Read the following statements:
Statement I: In a completely flexible exchange rate system, official reserve transactions are zero.
Statement II: Under a fixed exchange rate system, a deficit in the BoP is taken care of by the government through the use of its official reserves.
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: In a completely flexible exchange rate system, official reserve transactions are zero. — True. In a completely flexible system the central bank does not intervene, so it neither buys nor sells reserves. Only when it intervenes, as in managed floating, are reserve transactions not zero.
Statement II: Under a fixed exchange rate system, a deficit in the BoP is taken care of by the government through the use of its official reserves. — True. To hold the fixed rate, the government sells reserves to fill the gap.
NCERT (2026-27): “Flexible Exchange Rate … In a completely flexible system, the Central banks do not intervene in the foreign exchange market.” “6.2.3 Merits and Demerits of Flexible and Fixed Exchange Rate Systems … Often, if there is a deficit in the BoP, in a fixed exchange rate system, governments will have to intervene to take care of the gap by use of its official reserves. …” “6.2.4 Managed Floating … Under this system, also called dirty floating, central banks intervene to buy and sell foreign currencies in an attempt to moderate exchange rate movements whenever they feel that such actions are appropriate. Official reserve transactions are, therefore, not equal to zero.” |