Which statement describes a fixed exchange rate?

Which statement describes a fixed exchange rate?

• A. The currency is allowed to float freely with no government involvement.
• B. The government ties the value of its currency to another major currency or a basket of currencies.
• C. Value is determined purely by supply and demand in the market.
• D. The currency is pegged to be worth exactly one unit of gold.

Answer: (B)

A fixed exchange rate is when a country commits to keeping its currency at a specific value relative to another currency or a basket of currencies, and uses policy tools to defend that rate. This is exactly what the statement describes: the government ties the value of its currency to another major currency or a basket of currencies, and intervenes as needed to maintain that parity. The other descriptions point to a floating or market-determined regime, where the currency’s value moves with supply and demand and government intervention is minimal or absent. While tying to gold is a form of fixed value, modern treatments typically define a fixed exchange rate as a peg to another currency or basket, which is why the tying-to-currency/basket statement is the best fit.

A fixed exchange rate is when a country commits to keeping its currency at a specific value relative to another currency or a basket of currencies, and uses policy tools to defend that rate. This is exactly what the statement describes: the government ties the value of its currency to another major currency or a basket of currencies, and intervenes as needed to maintain that parity.

The other descriptions point to a floating or market-determined regime, where the currency’s value moves with supply and demand and government intervention is minimal or absent. While tying to gold is a form of fixed value, modern treatments typically define a fixed exchange rate as a peg to another currency or basket, which is why the tying-to-currency/basket statement is the best fit.