The advantage of flexible exchange rates free essay example. Therefore, the postbretton woods era starting in 1973 with its fiat currency and flexible exchange rates is no stranger to the international monetary system. The aim is to keep exchange rate close to desired target values. Describe the characteristics, advantages and disadvantages of a fixed exchange rate regime and a floating exchange rate regime. May, 2020 however, critics argue that fixed exchange rates can be difficult to maintain it may require highinterest rates and deflating the economy just to keep the currency at its target. Merits and demerits of flexible exchange rate of foreign currency. This paper shall elucidate the merits and demerits of the fixed. Fixed or stable exchange rates ensure certainty about the foreign payments and inspire confidence among the importers and exporters. Advantages and disadvantages of freely floating exchange rates. Pdf the dynamics of exchange rate regime in saudi arabia. The dollar is used for most transactions in international trade. Different exchange rate systems with pros and cons. On the other hand, when the same author makes a research on ronusd exchange rate, he concludes that the fluctuations of this exchange rate are mostly reflected by the.
However, this restricts independence of domestic economic policies. A comparative analysis of the impact of the fixed and. Fixed exchange rate system pegged exchange rate system. Today, most fixed exchange rates are pegged to the u. Perfectly fixed or pegged exchange rates would work much as a gold standard does. This study therefore, is an attempt to look at the fixed pegged exchange rate system, and the floating or flexible exchange rate system in terms of their advantages and disadvantages, and hence the desirability of one over the other. Correction of balance of payments deficits a floating exchange rate can depreciate to compensate for. Countries also fix their currencies to that of their most frequent trading partners. In the medium run, the real exchange rate is determined by the relative price of foreign to domestic goods, regardless of regime. A floating exchange rate s main advantage is that it adjusts itself automatically. Advantages and disadvantages of exchange rate systems advantages and disadvantages of fixed exchange rates advantages of fixed exchange rates.
Certainty with a fixed exchange rate, firms will always know the exchange rate and this makes trade and investment less risky. In between these two extreme rates, there are some hybrid systems like crawling peg, managed floating, etc. Advantages and disadvantages of a floating exchange rate. Under flexible exchange rate system, a country is free to adopt an independent policy to conduct properly the domestic economic affairs.
Therefore, in the interest of full disclosure, some of the disadvantages have been listed below. This brings both advantages and disadvantages, including the following. Which approach works best really depends on a given countrys economic realities. With a fixed exchange rate, the central bank must intervene to defend the fixed rate by buying domestic currency. Merits and demerits of flexible exchange rate system in hindi. Flexible exchange rates trigger considerable levels of volatility. Advantages and disadvantages of fixed exchange rates.
This paper shall elucidate the merits and demerits of the fixed and flexible exchange rate systems and also evaluate the preferable exchange. This short revision video looks at some of the key advantages and disadvantages of a country operating with a free floating exchange rate currency system. What are the advantages and disadvantages of flexible exchange. Also, currencies can be forced out of the fixed exchange rate undermining its supposed benefits. Jun 04, 2019 exchange rate regimes fixed, flexible and managed floating exchange rate and their merits and demerits types of exchange rate regimes. Flexible fixed advantages a fixed exchange rate should reduce uncertainties for all economic agents in the country. Flexible exchange rate system flexible exchange rate system works with change in supply and demand of the currency world wide. Explaining the difference between fixed and floating exchange. It also imposes economic disciplines on countries in deficit or surplus.
Absence of speculation with a fixed exchange rate, there will be no speculation if people believe that the rate will stay. In this system, central bank intervenes in the foreign exchange market to restrict the fluctuations in the exchange rate within certain limits. Critics of flexible exchange rates have also argued that flexible exchange rates would be subject to destabilizing speculation. What are the main advantages and disadvantages of fixed.
In a fixed exchange rate regime, national governments agree to maintain the. Exchange rate systems normally fall into one of the following categories, each of which is discussed in turns fixed. The advantages and disadvantages of flexible exchange. Exchange rate regimes, structural determiners, external determiners jel. This hampers foreign trade and capital movements between countries.
Please answer the following four discussion questions each worth 10 marks 1. Under the floating or flexible exchange rate system, exchange rates between different national currencies are allowed to the determined through market demand for and supply of them. Advantages and disadvantages of exchange rate systems. Typically, with a pegged exchange rate, an initial target exchange rate is set and the actual exchange rate will be allowed to fluctuate in a range around that initial target rate.
This revision video looks at fixed, managed floating and fixed exchange rates and considers some of the advantages drawbacks of each choice of currency sys. In a fixed exchange rate system, exchange rates either held. During the decades immediately following world war ii, the advantages of fixed exchange rates proved less powerful than earlier presumed. Under flexible exchange rate system, a country is free to adopt an. Pdf fixed versus flexible exchange rate systems researchgate. The flexible exchange rate system provides the government more flexibility, and they dont need to perpetuate large stocks of foreign exchange reserves. Advantages and disadvantages of fixed exchange rates syllabus. Murray 2003 suggests that the advantages of fixed exchange rates, such as the reduced transaction costs associated with converting and hedging currency. In other words, this study would consider what impact fixed and flexible exchange rates. This article lists down the pros and cons of freely floating currency system. Curr areas class outline fixed vs flexible exchange rates advantages and disadvantages mixed regimes. A pegged exchange rate system is a hybrid of fixed and floating exchange rate regimes.
Suppose that foreign demand for exports declines, and the current account balance deteriorates. Advantages disadvantages of fixed exchange rate a fixed. It was thought the absence of this risk was benefit international trade and capital flows. During these times, fiat currency and, consequently, flexible exchange rates ruled. International monetary system the george washington university. With flexible exchange rates, the nominal exchange rate adjusts to bring the real exchange rate into line. Advantages and disadvantages of floating exchange rates. Oct 28, 2020 a fixed exchange rate is when a country ties the value of its currency to some other widelyused commodity or currency. The necessary condition for an orderly and steady growth of trade demands stability in exchange rate. Advantages and disadvantages of fixed exchange rates advantages of fixed exchange rates. Compare and contrast a fixed exchange rate system with a floating exchange rate system, with reference to factors including the degree of certainty for stakeholders. Critically evaluate the flexible exchange rate system advantages and disadvantages.
Broadly, when government decides the conversion rate, it is. It also compares the same with the pros and cons of the fixed rate system. It would be a biased evaluation of the forex markets if attention was paid only to the advantages while ignoring the disadvantages. Is a fixed gold standard like exchange rate system for the globe warranted at this time. During wars and other military conflicts, the gold standard was abandoned. What are the advantages and disadvantages of both a fixed. However, various countries still imposed restrictions on the free convertibility of their currencies in view of their difficult balance of payment situation. The only difference is that, although the fiat currency flexible. Merits and demerits of flexible exchange rate system. Let us make an indepth study of the advantages and disadvantages of the flexible exchange rate system.
As the change in supply and demand occurs the fluctuation in rate of. The advantages and disadvantages of flexible exchange rates. The chief merit of the freely fluctuating exchange rate is that the bop disequilibrium gets corrected automatically with the change in exchange rate. A comparative analysis of the impact of the fixed and flexible. Disadvantages or demerits of flexible exchange rate. Among the fixed exchange rate options, all of which are inferior to current arrangements, a full monetary union is judged the most economically viable, though politically illiberal, while a pegged. It also discusses the advantages and disadvantages of fixed versus floating exchange rate regimes. A fixed, or pegged, rate is a rate the government central bank sets and maintains as the official exchange rate. As businesses have the perfect knowledge that the price is fixed and therefore not going to change they can plan ahead in their productions. The merits of floating compared to fixed exchange rates for any given country depends on how interdependent that country is with its neighbors.
Michael melvin, stefan norrbin, in international money and finance ninth edition, 2017. Explain the merits and demerits of flexible and fixed. Advantages disadvantages elimination of uncertainty and riskrisks associated with international trade and investment get minimized if exchange rates are fixed inconsistent with domestic currency speculation deterredtraders confidence that international. Since all these conditions are absent today, the smooth functioning of the fixed exchange rate system is not possible. Floating exchange rates have the following advantages. Usually government fixes the value of currency which leaves the foreign currency undervalued.
Economic policies can be more or less stable under a fixed exchange rate regime as compared to a floating one. Compare and contrast a fixed exchange rate system with a floating exchange rate system, with reference to factors including. Foreign exchange rate cbse notes for class 12 macro. A government might be forced to keep interest rates high or to reduce demand in the domestic economy. Exchange rate systems may be classified according to the degree by which exchange rates are controlled by the govt.
If the value of currencies fluctuates, significantly this can cause problems for. The key difference between the two are as follows the fixed exchange rate is the standard rate which is fixed by a monetary authority concerning foreign currency whereas the floating rate in the forex market is determined by demand and supply and it fluctuates constantly. Main types of foreign exchange rates your article library. This is done to keep the price of essential imported items as low as possible. In view of the above advantages, a fixed exchange rate system prevailed for a long time from 1944 to 1971.
As a consequence, if the exchange rate is flexible and not fixed, due to these large persistent deficits, the exchange rate or international value of their currencies. Merits and demerits of flexible exchange rate of foreign. This helps to promote international trade whereas one of the main disadvantage is that the prices were more flexible. In defence of fixed exchange rate system, it has been pointed out that it.
Let us make an indepth study of the advantages and disadvantages of the fixed exchange rate system. Fixed exchange rate an overview sciencedirect topics. Purposethis paper shall focus on the comparisons of the fixed and flexible exchange rate systems which are used by some countries. What are the advantages and disadvantages of flexible. Fixed vs flexible exchange rates advantages and disadvantages mixed regimes. Floating exchange rate definition, example advantages. In this article we will discuss about the advantages and disadvantages of floating exchange rates. There are various concepts of exchange rate systems. A fixed exchange rate removes the risk of exchange rate changes. The vital merit of flexible exchange rates is that movements in the exchange rate instinctively take care of the deficits and surpluses. Its two important types are fixed exchange rate and flexible exchange rate as explained below. Solved explain the advantages and disadvantages of.
Merits and demerits of flexible and fixed exchange rate. With the change in economic conditions underlying demand and supply, the exchange rate will automatically. Oct 31, 2012 what are the advantages and disadvantages of both a fixed exchange rate regime and a flexibleexchange rate regime. The resulting contraction of the domestic money supply and increase in interest rates reinforces the initial contraction in domestic output with a flexible exchange rate, the tendency towards a balance of payments deficit. Bias of the government or against exporter and importer will not be present. Introduction the choice of the exchange rate regime 1 is a complex decision making process of economic policy makers. Explaining the difference between fixed and floating. Fixed exchange rates, floating exchange rates, and currency. Any disequilibrium in the balance of payments would be automatically corrected by a change in the exchange rate. In other words, this study would consider what impact fixed and flexible exchange rates have. Under the flexible exchange rate system, exchange rate between different currencies, like the prices of commodities are freely determined by market forces, that is, by demand and supply forces.
What are the advantages and disadvantages of both a fixed exchange rate regime and a flexibleexchange rate regime. Fixed and floating exchange rates both have their advantages and disadvantages. Chapter 20 flexible versus fixed exchange rates, the european. Certainty with a fixed exchange rate, firms will always know the exchange rate and this makes trade and investment less risky absence of speculation with a fixed exchange rate, there will be no speculation if people believe that the rate will stay. This note describes different exchange rate regimes that are currently used in the world economy. This decision making process incorporates the analysis of advantages and disadvantages of fixed vs. Merits and demerits of fixed exchange rate of foreign currency. It is a hybrid of a fixed exchange rate and a flexible exchange rate system. Since flexible exchange rates cause uncertainties about the future exchange rates, individuals, companies and institutions are reluctant to lend to and borrow from the internal money and capital markets. The temporary or cyclical exchange rate stability will transmit price instability which may discourage trade and, hence, reduce economic welfare. All currencies would fix their exchange rate in terms of another currency, say, the dollar, and thereby would fix their rate relative to every other currency.
By pegging one currency to another, there is less fluctuation when exchanging money or trading between countries. Flexible exchange rate system is claimed to have the following advantages. Dec 05, 2019 demerits of flexible exchange rate system. What are the advantages and disadvantages of fixed exchange rates.
Contrast the fixed exchange rate system of the gold standard with the pure floating of a flexible exchange rate system. Any undue fluctuations in exchange rate cause problems to the plans and programmes of. Floating exchange rate regimes are market determined. Critically evaluate the flexible exchange rate system. Under flexible exchange rate system, a country is free to adopt an independent. The main demerits of flexible exchange rate are as follows. Under bretton woods system fixed exchange rate system was adopted by various countries. By maintaining a fixed rate of exchange to the dollar or some other currency, each countrys inflation rate is anchored to the dollar, and thus will follow the policy established for the dollar.
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