Question

Many developing countries, like Mexico, have moderate to high rates of inflation. At the same time, international trade plays an important role in their economies. What type of exchange rate regime would be best for such a country’s currency; vis à vis; the U.S. dollar?

a) Fixed exchange rate
b) Floating exchange rate
c) Managed float exchange rate
d) Pegged exchange rate

Answer 1

A managed float exchange rate might be the best regime for a country like Mexico with moderate to high inflation rates and significant international trade, as it offers both flexibility and some level of government control.

Step-by-step explanation:

For a country like Mexico, which faces moderate to high inflation rates and for which international trade is significant, choosing the right exchange rate regime for its currency relative to the U.S. dollar is crucial to its economic stability. A floating exchange rate would allow the currency value to be determined by market forces, whereas a fixed exchange rate requires the government to maintain the currency value against a benchmark, often at the cost of high foreign reserves. A managed float or pegged exchange rate could provide a middle ground, allowing the government some control to stabilize the currency when necessary, while still benefiting from the flexibility of a floating rate. Considering these options, a managed float exchange rate might be the most suitable, as it allows the government to intervene in the foreign exchange market to manage the currency's value without the rigidity of a fixed rate, potentially helping to balance the effects of inflation and participate effectively in international trade.