Answer:
Since 1994, China has fixed the Yuan to the dollar at a rate of 8.28. Whenever it changes from this, it usually is not as a result of the market forces as is the case in a floating exchange rate system.
The Merits of a Fixed Exchange Rate to China
- One of the benefits of the fixed exchange rate to China is that the global market players are motivated to buy its goods. For as long as the Yuan is lower to most currencies in the world and remains fixed, other currencies would be able to afford more of Chinas goods.
- Certainty. The certainty that comes with having a fixed exchange rate also helps buyers in the global market place to plan. It has a way of increasing their confidence in the Yuan.
- Fixed exchange rates may ensure that the rate of inflation remains low. This in the long run also helps to keep the interest rates low as well.
Demerits of a Fixed Exchange Rate to China
- One of the potential pitfalls to China's currency inflexibility is that it will require a large reserve to buffer the economy if the currency comes under economic pressure.
- This system is hurting China's economy because, when the currency is undervalued, it will not be able to make adjustments nor enjoy the benefits of a strengthening currency. When a currency becomes stronger, this means that the price of its imports will fall. A strong currency also helps ensure reduced inflation.
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