Weekly Assignment # 2 - Chapter 3 Questions 4 The...

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Chapter # 3 Questions: 4. The Impossible Trinity. Explain what the term impossible trinity means and why it is true. Exchange rate stability : Countries with floating rate regimes can maintain monetary independence and financial integration but must sacrifice exchange rate stability. Full financial integration: Countries with tight control over capital inflows and outflows can retain their monetary independence and stable exchange rate, but surrender being integrated with the world’s capital markets. Monetary independence: Countries that maintain exchange rate stability by having fixed rates give up the ability to have an independent monetary policy. 6. Emerging market exchange rate regimes: High capital mobility is forcing emerging market nations to choose between free-floating regimes and currency board or dollarization regimes. What are the main outcomes of each of these regimes from the perspective of emerging market nations? Emerging Market Country: Free Floating Regime: o Currency value is free to float up and down with international market forces o Independent monetary policy and free movement of capital allowed, but at the loss of stability o Increased volatility may be more than what a small country with a small financial market can withstand Currency Board or Dollarization: o Currency board fixes the value of local currency to another currency or basket; dollarization replaces the currency with the U.S. dollar o Independent monetary policy is lost; political influence on monetary policy is eliminated o Seignorage, the benefits accruing to a government from the ability to print its own money, are lost 12. Exchange rate regime classifications: The IMF classifies all exchange rate regimes into eight specific categories that are summarized in this chapter. Under which exchange rate regime would you classify the following countries? Page 70 a) France: Exchange arrangement with no separate legal tender b)
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