Instructor’s Manual
CHAPTER 15
EXCHANGE-RATE SYSTEMS AND CURRENCY CRISES
CHAPTER OVERVIEW
This chapter conducts a survey of exchange-rate systems and identifies the economic factors that influence the
choice of alternative exchange-rate systems.
The chapter begins by identifying the factors that underlie a nation’s decision to allow its currency to be determined
by free market forces or to be fixed against some standard of value. It is noted that small, developing nations tend
to peg their currencies to a single currency or a currency basket. Pegging to a single currency is generally used by
With the breakdown of the Bretton Woods system in the early 1970s, the major industrial nations adopted a system
of managed floating exchange rates. Under this system, central bank intervention in the foreign exchange market is
intended to prevent disorderly market conditions in the short run. In the long run, exchange rates are allowed to
float in accordance with changing supply and demand conditions.
After completing the chapter, students should be able to:
• Identify the criteria which underlie a nation’s preference for fixed exchange rates or floating exchange rates.
• Explain the importance of the special drawing right for the international monetary system.
Instructor’s Manual
BRIEF ANSWERS TO STUDY QUESTIONS
1. The choice of floating exchange rates versus pegged exchange rates relates to the economic and political
2. Managed floating exchange rates utilize the philosophy of “leaning against the wind,” in which exchange
3. Currency boards and dollarization are seen as methods of stabilizing exchange rates of developing countries.
4. The adjustable-pegged exchange rate system attempted to provide essentially fixed exchange rates for
6. Exchange controls, including the rationing of foreign exchange among domestic importers, are sometimes
used to help a nation gain control over its balance-of-payments position.
7. Among the causes of currency crises are budget deficits financed by inflation, weak financial systems, political
9. The SDR is a currency basket composed of the currencies of the five IMF countries having the largest shares
of world exports. The basket valuation technique allows the SDR’s value to be more stable than the value of
Instructor’s Manual