"A country that initially has a floating exchange rate and a high inflation rate can use a shift to a fixed exchange rate as part of its effort to lower its inflation rate." Is the statement correct? Why or why not?
What will be an ideal response?
POSSIBLE RESPONSE: The statement is correct. With fixed exchange rates countries should have about the same inflation rates. This creates a discipline effect on high-inflation countries. For the fixed exchange rate to be sustained, a country cannot have an inflation rate that is much above the inflation rates of its partners. A country with a serious effort to reduce its high inflation rate may deliberately choose to fix its currency to the currency of another country that has a lower inflation rate, as a signal of how serious it is and may use this as external pressure on itself.
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