If most of the shocks that buffet the economy come from the output market shocks, then
A) fixed exchange rates are better than flexible exchange rates.
B) flexible exchange rates are better than fixed exchange rates.
C) which system is chosen is not important.
D) fixed exchange rates are better than flexible exchange rates only in the short run.
E) flexible exchange rates are better than fixed exchange rates only in the short-run.

Question

Quizplus · Accepted Answer

Flexible exchange rates allow for automatic adjustment to output market shocks. If output decreases, the demand for domestic currency decreases, causing a depreciation in the exchange rate. This makes exports cheaper and more attractive, stimulating demand and helping to mitigate the shock. Conversely, if output increases, the demand for domestic currency increases, causing an appreciation in the exchange rate. This makes imports cheaper, stimulating demand and again helping to mitigate the shock. Fixed exchange rates do not allow for this automatic adjustment and can exacerbate output market shocks.

If Most of the Shocks That Buffet the Economy Come