If a government is unwilling to accept occasional deflation and inflation caused by balance of payments adjustments,
A) it cannot maintain a fixed exchange rate system.
B) it must maintain a fixed exchange system.
C) it can both stabilize exchange rates and domestic prices at the same time.
D) it cannot trade with other countries.
E) it cannot maintain a floating exchange system.

Question

Quizplus · Accepted Answer

If a government is unwilling to accept occasional deflation and inflation caused by balance of payments adjustments, it cannot maintain a fixed exchange rate system. Fixed exchange rate systems require a government to intervene in the foreign exchange market in order to maintain a fixed exchange rate. If the government is not willing to let prices adjust, then it cannot maintain a fixed exchange rate without incurring significant economic costs.

If a Government Is Unwilling to Accept Occasional Deflation and Inflation