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Suppose a country has fixed exchange rate and no capital controls. The country has kept the...

Suppose a country has fixed exchange rate and no capital controls. The country has kept the value of its currency below its market level.

(a) Why is it easier for a country to undervalue its currency than to overvalue it?

(b) What is the (intended) effect of this policy on current account, capital account, overall balance of payments and international reserves?

(c) What will be the effect on current account, capital account, balance of payments and international reserves if the exchange rate is allowed to float?

(d) Discuss the effectiveness of monetary policy for this country during the financial crisis. Now, due to a political crisis, projections for economic growth in coming years are revised sharply downwards. As a result of new projections, savers wish to purchase financial assets in other countries.

(e) Will the country be able to maintain the exchange rate?

(f) Capital flows can cause problems for exchange rate stability. So, why do most countries allow the free movement of capital?

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