Under a flexible exchange rate system, which of the following statements are correct?
(A) In a completely flexible system, central banks do not intervene in the foreign exchange market.
(B) An increase in the rupee-dollar exchange rate means that the rupee has appreciated.
(C) A rise in interest rates at home often leads to an appreciation of the domestic currency.
(D) A country whose aggregate demand grows faster than the world’s normally finds its currency appreciating.
(E) If Indians expect the pound to appreciate, the rupee-pound exchange rate tends to rise now.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (A), (C) and (E) only
Under a flexible rate, demand and supply set the rate. A rise in the rupee-dollar rate means the rupee has depreciated.
(A) In a completely flexible system, central banks do not intervene in the foreign exchange market. — Correct. The market alone sets the rate.
(B) An increase in the rupee-dollar exchange rate means that the rupee has appreciated. — Incorrect. More rupees per dollar is depreciation of the rupee.
(C) A rise in interest rates at home often leads to an appreciation of the domestic currency. — Correct. Funds flow in to earn the higher interest.
(D) A country whose aggregate demand grows faster than the world’s normally finds its currency appreciating. — Incorrect. Its imports grow faster than its exports, so its currency depreciates.
(E) If Indians expect the pound to appreciate, the rupee-pound exchange rate tends to rise now. — Correct. They buy pounds now, so demand for pounds rises today.
NCERT (2026-27): “Flexible Exchange Rate … In a completely flexible system, the Central banks do not intervene in the foreign exchange market.” “Interest Rates and the Exchange Rate … Thus, a rise in the interest rates at home often leads to an appreciation of the domestic currency. …” “Income and the Exchange Rate … In general, other things remaining equal, a country whose aggregate demand grows faster than the rest of the world’s normally finds its currency depreciating because its imports grow faster than its exports. Its demand curve for foreign currency shifts faster than its supply curve.” “Speculation … This expectation would increase the demand for pounds and cause the rupee-pound exchange rate to increase in the present, making the beliefs self-fulfilling.” |