Question

Suppose Connecticut becomes an independent nation and has its own central bank called the Bank of Connecticut. In this scenario, the Bank of Connecticut issues its currency called the Charter Oak dollar. Should the Bank of Connecticut fix the Charter Oak dollar with the U.S. dollar used by the remaining 49 U.S. states? Explain your reasoning

Answer 1

If Connecticut becomes an independent Nation and has its own Central bank and its own currency, than the Bank of Connecticut should fix the Charter Oak Dollar with the U.S. Dollar used by the remaining 49 States.

The main reason for following a fixed exchange rate system or a pegged rate system is that the Connecticut will be a small country as compared to the U.S. and its most of the economic activities will be with the US states and hence it will have US dollar as its largest proportion of foreign currency. So if they follow pegged rate system, it will stabilize and secure the the currency of the country and as a result the economy of Connecticut will be stable.

If they follow freely floating exchange rate system, than there is a high chance that the Charter Oak Dollar will loose its value in few years and hence there will be a great loss to the Connecticut in foreign trade.