Which is preferable a fixed or a flexible exchange rate Why?
Fixed exchange rates help bring stability to a country's economy and attract foreign investment. Floating exchange rates work better for countries that already have a stable and effective monetary policy.
In general, a fixed exchange rate (or a greater degree of fixity) is preferable if the disturbances impinging on the economy are predominantly monetary –such as changes in the demand for money–and thus affect the general level of prices.
Understanding a Fixed Exchange Rate
Fixed rates provide greater certainty for exporters and importers. Fixed rates also help the government maintain low inflation, which, in the long run, keep interest rates down and stimulates trade and investment.
A fixed exchange rate helps to ensure the smooth flow of money from one country to another. It helps smaller and less developed countries to attract foreign investment. It also helps the smaller countries to avoid devaluation of their currency and keep inflation stable.
Answer and Explanation: Fixed exchange rates make more concerned about the currency value of the country. It promotes an increased rate of interest, and it also has no flexibility in international business. The floating exchange rate provides stability between the demand and supply of the international business.
The main advantage of a flexible exchange rate regime is that it allows the government and the central bank to pursue their own macroeconomic goals, such as price stability, output growth, or employment, without being constrained by the exchange rate.
Flexible exchange rates have the advantage that they allow a country to pursue an independent monetary policy, rather than have its own monetary policy set by an anchor currency country.
| Fixed Pros | Fixed Cons |
|---|---|
| Enable the currency's value to remain stable | Central bank must intervene often |
| Can help lower inflation which encourages investment | Country loses monetary independence |
| The Central Bank has the power to maintain rate | Can be expensive to maintain |
- Uncertainty and Confusion: The flexible exchange rate system causes uncertainty and confusion in trade and investment. ...
- Inflationary Effect: Under a flexible exchange rate system, the chances of the inflationary effect of exchange depreciation on a country's domestic price level are more.
A pegged rate, or fixed exchange rate, can keep a country's exchange rate low, helping with exports. Conversely, pegged rates can sometimes lead to higher long-term inflation. Maintaining a pegged exchange rate usually requires a large amount of capital reserves.
What is the biggest disadvantage of a fixed exchange rate?
Disadvantages of a Fixed Exchange Rate
Lack of Monetary Policy Flexibility: Countries lose the ability to set their own interest rates and conduct independent monetary policy, as they must focus on maintaining the peg.
Most developing or emerging market economies use fixed exchange rates for their currencies. This provides exporting and importing countries more stability and also keeps interest rates low.
- Aruba.
- The Bahamas.
- Bahrain.
- Hong Kong.
- Iraq.
- Saudi Arabia.
A fixed exchange rate can be expensive to maintain. A country must have enough foreign exchange reserves to manage its currency's value. A fixed exchange rate can make a country's currency a target for speculators. They can short the currency, artificially driving its value down.
Flexible or Floating exchange rate system refers to a system in which the exchange rate of different currencies is determined by the forces of demand and supply in the foreign exchange market. Was this answer helpful?
The terms "stronger" and "weaker" are used to compare the value of a specific currency (such as the U.S. dollar) relative to another currency (such as the euro). A currency appreciates in value, or strengthens, when it can buy more foreign currency than previously.
If a currency depreciates and later re- covers its original level, a net inflationary result remains. Thus a system of flexible exchange rates makes all the participating economies more prone to inflation.
Exchange rate risk refers to the risk that a company's operations and profitability may be affected by changes in the exchange rates between currencies. Companies are exposed to three types of risk caused by currency volatility: transaction exposure, translation exposure, and economic or operating exposure.
Possibility of a dilemma
Lacking effective control on the free movement of capital, the impossible trinity asserts that a country has to choose between reducing currency volatility and running a stabilising monetary policy: it cannot do both.
Drawbacks of Free-Floating Exchange Rates:
Currency Risk: The volatility of exchange rates introduces currency risk for businesses and investors. Inflation Pass-Through: Exchange rate fluctuations can lead to changes in import prices, which can impact domestic inflation.
What is an advantage of a fixed exchange rate quizlet?
An advantage of a fixed exchange rate system is that governments are not required to constantly intervene in the foreign exchange market to maintain exchange rates within specified boundaries.
- Preventing adjustments for currencies that become under- or over-valued.
- Limiting the extent to which central banks can adjust interest rates for economic growth.
- Requiring a large pool of reserves to support the currency if it comes under pressure.
Lack of Flexibility: One of the main drawbacks of a fully fixed exchange rate system is the lack of flexibility in responding to external economic shocks. Countries cannot independently adjust their exchange rates to address changing economic conditions.
Fixed exchange rates reduce foreign exchange risk for companies with cross border trade. The major disadvantage of fixed exchange rate system is that it establishes a direct link between domestic and foreign inflation and employment.
A fixed exchange rate is a regime imposed by a government or central bank which ties the official exchange rate of the country's currency with the currency of another country or the gold price. A fixed exchange rate system has the aim of keeping the value of a currency within a narrow band.
