Macroeconomics

Explaining Exchange Rates

Suppose that under the Bretton Woods system, the dollar is pegged to gold at a rate of $35 per ounce and the pound sterling is pegged to the dollar at a rate of $2 = £1.

If the dollar is devalued against gold and the pegged rate is changed to $40 per ounce, what does this imply for the exchange value of the pound? Explain your answer.

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  1. Think it through. 1oz = $35 and $2=L1, so 1oz = L17.5
    Now then, if 1oz = $40 and 1oz remains at L17.5 then $40 = L17.5 or 40/17.5 = L1 or $2.286 = L1

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