Read the following statements:
Statement I: The main feature of a fixed exchange rate system is that there must be credibility that the government will be able to maintain the exchange rate at the level specified.
Statement II: Through intervention in the foreign exchange market, the government can maintain any exchange rate in the economy.
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Both Statement I and Statement II are true.
Statement I: The main feature of a fixed exchange rate system is that there must be credibility that the government will be able to maintain the exchange rate at the level specified. — True. If people doubt the government can hold the rate, a speculative attack can follow.
Statement II: Through intervention in the foreign exchange market, the government can maintain any exchange rate in the economy. — True. The RBI buys or sells dollars to absorb the gap at the fixed rate, though it gains or loses reserves while doing so.
NCERT (2026-27): “Fixed Exchange Rates … At this exchange rate, the supply of dollars exceeds the demand for dollars. The RBI intervenes to purchase the dollars for rupees in the foreign exchange market in order to absorb this excess supply which has been marked as AB in the figure. Thus, through intervention, the Government can maintain any exchange rate in the economy. But it will be accumulating more and more foreign exchange so long as this intervention goes on.” “6.2.3 Merits and Demerits of Flexible and Fixed Exchange Rate Systems The main feature of the fixed exchange rate system is that there must be credibility that the government will be able to maintain the exchange rate at the level specified. …” |