Consider the following statements and choose the correct option:
Statement 1: Unlimited convertibility and fixed price conversion affect the credibility of a currency system.
Statement 2: The international monetary system was established to regulate internal fiscal policies of countries.
Show answer & explanation
Correct answer: A
Explanation
The correct answer is option 1 i.e. Only Statement 1 is correct.
Analysis of the Statements
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Statement 1 (Correct): In a fixed exchange rate system, promising unlimited convertibility at a fixed price can severely strain a nation's foreign exchange reserves. If the market loses faith in the currency's value, massive sell-offs occur. If the government cannot fulfill the conversion promise due to depleted reserves, the system collapses, destroying the currency's credibility.
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Statement 2 (Incorrect): The international monetary system (like the IMF) was primarily established to oversee exchange rates, manage international payments, and provide financial stability. It does not have the legal authority to regulate the internal fiscal policies (taxation and government spending) of sovereign nations, which remain under domestic control.