Question 1 1. a. What are the five basic mechanisms for establishing exchange rates? b. How does each work? c. What costs and benefits are associated with each mechanism?

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: Understand the five basic mechanisms for establishing exchange rates.      : Explain how market determination works. : Explain how fixed exchange rates work. : Explain how pegged exchange rates work. : Explain how managed float (dirty float) works. : Explain how currency boards work. : Discuss the costs and benefits associated with each mechanism. The five basic mechanisms for establishing exchange rates are market determination, fixed exchange rates, pegged exchange rates, managed float (dirty float), and currency boards. Market determination allows for automatic adjustments to economic imbalances but can create uncertainty for businesses and investors. Fixed exchange rates reduce exchange rate volatility but can lead to a loss of foreign exchange reserves and moral hazard. Pegged exchange rates provide stability and credibility but can lead to economic distortions. Managed float (dirty float) allows for some flexibility in managing the exchange rate while still providing a degree of stability. Currency boards provide a high degree of exchange rate stability and credibility but limit monetary policy autonomy and potentially expose the economy to currency crises.

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: Understand the five basic mechanisms for establishing exchange rates.

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