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Fixed and floating exchange rates

“The case for floating exchange rates is that with fixed exchange rates and nominal price rigidity the economy adjusts slowly to terms of trade shocks. Floating exchange rates permit a change in the nominal exchange rate and this facilitates the necessary change in the real exchange rate required in the face of such real shocks”. Explain and evaluate this statement with reference to the UK’s possible adoption of the Euro.

language english
wordcount 2160 (cca 6 pages)
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Table of contents

Page 1 -Intro
Page 2-3-Models
Page 4 -Conclusion

Preview of the essay: Fixed and floating exchange rates

When studying whether the UK should adopt the euro, it is essentially a choice between a fixed or a floating exchange rate regime. This is because a fixed exchange rate can only really be exercised if “countries are willing to maintain controls over capital movements (as China does), or, at the other extreme, move to a shared single currency with their monetary partners (as in Europe).” (Krugman 2006,450) In this essay, the fixed exchange ...

... apparent that a fixed exchange rate can act as a stabiliser when financial shocks take place and there are intrinsic microeconomic benefits when implementing a common currency in a region. These viewpoints concerning fixed exchange rate, favour the use of a common currency in an optimal currency area. Thus, in adopting the euro, and consequently, a fixed exchange rate system, the UK would sacrifice control of economic policy. However, overall, full involvement in EMU would benefit the UK both politically and economically, outweighing the losses associated with trade shocks.
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Capital Markets & Exchanges
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