4.2.6.4 Exchange rate systems Quiz: AQA Economics, Unit 2

The 20 questions

1. In a freely floating exchange rate system, how is the exchange rate determined?

   • By the interaction of demand and supply for the currency in foreign exchange markets
   • By the price of gold in world markets alone
   • By the government, which sets a fixed rate each day
   • By the central bank, which must hold the rate at a target

2. What is a fixed exchange rate system?

   • A system in which a currency is not traded with any other currency
   • A system in which the price of imports is fixed by law
   • A system in which the government or central bank maintains the currency at a set value against another currency
   • A system in which the exchange rate is set by market demand and supply with no intervention

3. How can a government intervene to influence the exchange rate?

   • By setting the price of every good sold in the country
   • By printing money to pay for all imports
   • By setting the level of unemployment directly
   • By buying or selling foreign currency reserves, or by changing interest rates

4. What is one advantage of a floating exchange rate system?

   • It can adjust automatically to correct balance of payments imbalances
   • It removes all risk from international trade
   • It means the government never needs to make economic decisions
   • It guarantees a fixed value of the currency against all others

5. What is one disadvantage of a floating exchange rate system?

   • It forces the central bank to hold large reserves of foreign currency
   • Exchange rate volatility can create uncertainty for firms that trade internationally
   • It requires all trade to be conducted in a single currency
   • It means prices can never change in the domestic economy

6. What is a currency union?

   • A group of countries that agree tariffs on imports from other countries
   • A group of countries that agree to use each other's currencies at fixed prices only for tourism
   • A group of countries that share a single currency and a common monetary policy
   • A group of countries that each have their own currency and fixed exchange rates with no trade

7. What is one advantage for members of a currency union such as the eurozone?

   • It removes exchange rate transaction costs and exchange rate uncertainty between members
   • It guarantees full employment in every member country
   • It allows each member to set its own interest rates with no constraints
   • It removes the need for any trade between members

8. A rise in demand for UK exports increases the demand for sterling. What is the likely effect on the exchange rate in a floating system?

   • The pound appreciates
   • The pound is unaffected, because exports do not affect the exchange rate
   • The pound depreciates
   • The pound becomes fixed at its previous value

9. A government wants to support its currency's value. Which action is most direct?

   • Reducing the number of foreign currencies it accepts
   • Printing more of its own currency and giving it to banks
   • Buying its own currency using foreign currency reserves
   • Selling its own currency in large quantities

10. What is a key disadvantage of a fixed exchange rate for a country's monetary policy?

    • It means the government must set the price of every good
    • It limits the central bank's ability to set interest rates to meet domestic objectives
    • It makes it impossible to trade with any other country
    • It means the central bank cannot hold any foreign currency reserves

11. Why might a eurozone member struggle to correct a domestic downturn with exchange rate changes?

    • The euro is not used for trade, so exchange rates have no effect
    • The European Central Bank sets wages, so the member has no tools to act
    • It cannot devalue its own currency, so it must adjust through wages, prices and fiscal policy instead
    • It can devalue its own currency at will, so it never faces a downturn

12. What is a speculative attack on a fixed exchange rate?

    • A decision by the central bank to hold more reserves of foreign currency
    • A government announcement that it will raise the exchange rate by a small amount
    • A rise in exports that increases demand for the currency
    • Large sales of a currency by speculators who expect the authorities cannot defend the peg

13. Higher UK interest rates attract large inflows of short-term capital in a floating system. What is the likely effect?

    • The pound depreciates, which makes exports cheaper
    • The pound appreciates, which can make exports less competitive
    • The pound is unaffected, because capital flows do not affect exchange rates
    • The pound becomes fixed, because capital inflows prevent any change

14. The exchange rate is 1 pound equals 1.25 dollars. A US good costs 50 dollars. What is its cost in pounds?

    • 50 pounds
    • 40 pounds
    • 0.04 pounds
    • 62.50 pounds

15. Evaluate whether a floating exchange rate is preferable to a fixed rate for a small open economy.

    • The choice makes no difference to the economy in any circumstance
    • A floating rate is always better, because it removes all risks for trade
    • A fixed rate is always better, because it removes all policy constraints
    • It depends: floating gives monetary independence but adds volatility, while fixed rates offer stability at the cost of policy freedom

16. Why does membership of a currency union limit macroeconomic policy for each member?

    • Membership removes the need for any government spending or taxation
    • Members are free to set any interest rate and exchange rate they wish
    • Membership means the country cannot trade with countries outside the union
    • Members cannot set their own interest rates or exchange rates, so they must rely on common policy and internal adjustments

17. Evaluate the benefits and costs of a currency union such as the eurozone for its members.

    • Benefits are large and there are no costs, because all members face identical shocks
    • Benefits are lower transaction costs and trade stability; the cost is lost policy flexibility when members face different shocks
    • The union has no benefits or costs, because members can always act alone
    • Costs are large and there are no benefits, because members lose all trade

18. Explain how an increase in UK interest rates can affect aggregate demand through the exchange rate.

    • Higher rates have no effect on the exchange rate, so aggregate demand is unaffected
    • Higher rates lower the pound, which raises net exports and increases aggregate demand
    • Higher rates raise the pound, which lowers net exports and reduces aggregate demand
    • Higher rates reduce the money supply, so the pound falls and demand rises

19. Evaluate the effectiveness of government intervention in the foreign exchange market.

    • Intervention is always fully effective, whatever the size of speculative flows
    • Intervention always increases the risk of inflation, so it should never be used
    • It may be limited when large speculative flows overwhelm reserves, though it can be effective with credibility and policy support
    • Intervention has no effect on the currency in any circumstance

20. A country's currency falls sharply under a floating rate. What is the most likely effect on the price of its imports?

    • Import prices fall because domestic demand rises
    • Import prices are unaffected, because exchange rates affect only financial markets
    • Imports become cheaper in domestic currency terms
    • Imports priced in foreign currency cost more in the domestic currency

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