Country X wants to lower the value of its currency on the foreign exchange market. Under a flexible exchange rate system, how can it do that?

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Country X wants to lower the value of its currency on the foreign exchange market. Under a flexible exchange rate system, how can it do that?

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Country X wants to lower the value of its currency on the foreign exchange market. Under a flexible exchange rate system, how can it do that?

Explanation & AnswerSolution by a verified expert

Explanation
The flexible exchange rate system is a system where the rate is determined by the forces of demand and supply of currencies in the foreign exchange market.

Under a flexible exchange rate system, the factors like difference in the growth rate of income, the difference in the inflation rate, and the difference in the real interest rate of interest will cause the equilibrium exchange rate to change. An increase in the income, the difference in the inflation rate, and decreasing real interest rate will lead to a depreciation of the domestic currency of Country X.

The flow of financial capital depends on the real interest rate of different countries. A decrease in the real interest in Country X will decrease the demand for financial assets by the foreign country. This will decrease the demand for the currency of Country X in the foreign exchange market. The foreign exchange rate will change as now more currency of X will be needed to buy a foreign currency which will result in the foreign currency to appreciate and that of Country X depreciate.

Verified Answer
An increase in income, reduction in the inflation rate, and increased real interest rate will lower the value of the currency.

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