Q. With reference to the Flexible Exchange Rate system, consider the following statements:
1.In a flexible exchange rate regime, the value of a currency is determined entirely by the forces of demand and supply in the foreign exchange market.
2.An increase in demand for foreign currency leads to depreciation of the domestic currency under a flexible exchange rate regime.
3.Central banks frequently intervene in the foreign exchange market to stabilize the exchange rate in a purely flexible exchange rate system.
Which of the statements given above is/are correct?
Answer: A
Notes:
Explanation:
- Under a flexible (floating) exchange rate system, the exchange rate is determined purely by market forces — i.e., demand and supply of foreign exchange — without government or central bank interference.
- When demand for foreign currency (like the US dollar) increases, the domestic currency (like the Indian rupee) depreciates because more rupees are needed to buy the same amount of dollars.
- In a purely flexible exchange rate system, central banks do not intervene. Intervention happens under managed float or fixed exchange rate systems.
Source: Economy (NCERT)
