7. Fixed exchange rates Consider the exchange rate between the Moroccan dirham a

Question

7. Fixed exchange rates Consider the exchange rate between the Moroccan dirham and the euro. Suppose the Moroccan government and the Eurozone governments agree to fix the exchange rate at 2.5 dirham per euro, as shown by the grey line on the following graph. Refer to the following graph when answering the questions that follow. 3.5 Supply of Euros 2.5 u 1.5 1.0 Demand for Euros 0.5 0 2 4 6 8 10 12 14 16 QUANTITY OF EUROS (Billions) At the official exchange rate of 2.5 dirham per euro, the euro is Moroccans pay - , and the Moroccan dirham is which means that for European exports than they would with a free-floating exchange rate.

Explanation / Answer

The market or equilibrium exchange rate is 2 dirhams per euro so this means euro is 1) overvalued and dirham is 2) undervalued

This implies that Morrocans would have been paying 2 dirhams for buying 1 euro in free market whereas now they pay 2.5 dirhams so they pay 3) more to import European goods. Similarly they receive more dirhams when they export to Europian nations.

At the fixed exchange rate of 2.5 dirhams per euro, there is a greater supply of euro (S) than its demand (D). Hence there is a 4) surplus of euro.

When the governments agree to bring down the exchange rate, this will imply a 5) devaluation of euro and 6) revaluation of dirhams

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