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Question 19M.3.HL.TZ0.j

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Date May 2019 Marks available [Maximum mark: 4] Reference code 19M.3.HL.TZ0.j
Level HL Paper 3 Time zone TZ0
Command term Explain Question number j Adapted from N/A
j.
[Maximum mark: 4]
19M.3.HL.TZ0.j

Tanya is a currency speculator. She buys and sells currencies with the intention of making gains as a result of changes in the exchange values of currencies. Currently, she is holding US$300 000, but she expects that in the next few months the euro (EU€) (the currency of the eurozone) will appreciate against the US dollar (US$).

At present, EU€1 = US$1.20.

Tanya exchanges her US$ for EU€.

The EU€ depreciates by 10 % against the US$. Fearing further depreciation of the EU€, Tanya exchanges her EU€ for US$.

Explain two reasons why a government might prefer a floating exchange rate system for its currency.

[4]

Markscheme

Reasons may include:

  • a floating exchange rate system allows for independent monetary policy. Interest rates can be set in order to influence AD without fear of disrupting the (fixed) exchange rate
  • the economy can use exchange rate policy to affect macroeconomic variables, such as the growth rate; inflation)
  • if an economy has a current account deficit/surplus, the exchange rate will act as a self-regulating mechanism to restore the balance
  • the central bank does not need to maintain foreign reserves: (involving an opportunity cost) to be able to intervene in the foreign exchange market.

Any other reasonable response should be rewarded.

Examiners report

Lower achieving responses simply described how a floating exchange rate works, and implied that this was an advantage, while others stated that it was “easier” or “cheaper” for the government if the exchange rate was allowed to float. Several views were expressed as to the likelihood of currency speculation. In contrast, many responses explained clearly the advantages regarding independence of demand-side policies and the removal of a requirement to hold significant reserves of foreign currency (bearing an opportunity cost) under a fixed exchange rate system.

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