An international trade shock arising from a sudden increase in import demand is likely to be least disruptive to a country with:
A)a floating exchange-rate system.
B)a fixed exchange-rate system with sterilization.
C)a fixed exchange-rate system without sterilization.
D)a surplus in the overall payment balance.

Question

Quizplus · Accepted Answer

In a floating exchange-rate system, the exchange rate can adjust to changes in import demand, helping to mitigate the impact of the trade shock on the domestic economy. In contrast, fixed exchange-rate systems, with or without sterilization, can lead to imbalances in the economy and potentially more severe disruptions in the face of sudden changes in import demand. A surplus in the overall payment balance may provide some cushioning, but it may not fully offset the effects of the trade shock.

An International Trade Shock Arising from a Sudden Increase in Import