Fixed Versus Floating Exchange Rate

8/7/2019 Fixed Versus Floating Exchange Rate

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Fixed Versus Floating

Exchange Rate


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EXCHANGE RATE

An exchange rate is theprice at which onecountry's currency trades

for another on the foreignexchange market


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Fixed Exchange Rate

A fixed exchange rate, the government

is unwilling to let the country'scurrency float freely, and they state alevel at which the exchange rate willstay. The government takes whatever

measures that are necessary tomaintain the rate and prevent it fromfluctuating.


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Such a system often seems appealing to

those who are troubled by theuncertainties of the present, highlyvolatile, floating rate environment.


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FIXED EXCHANGERATE

FIXED EXCHANGE

RATE

PEGGED EXCHANGE

RATE.


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Pros of Fixed Exchange Rate

There is certainty in fixed exchangerate. With it, international trade andinvestment becomes less risky.

There is little or no speculation on afixed exchange rate.


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Cons of Fixed Exchange Rate

However, a fixed exchange ratecontradicts the objective of having

free markets and it is not able toadjust to shocks swiftly like thefloating exchange rate.


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Floating Exchange Rate

The floating exchange rate is a

market-driven price for currency,whereby the exchange rate isdetermined entirely by the free

market forces of demand andsupply of currencies with nogovernment interventionwhatsoever.


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FLOATINGEXCHANGE

RATE

INDEPENDENT

FLOATING

SYSTEM

MANAGED

FLOATING

SYSTEM


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Pros of Floating Exchange Rate

There is automatic correction in the

floating exchange rate as the countrysimply lets it move freely to theequilibrium of demand and supply

There is insulation from externaleconomic events as the country'scurrency is not tied to a possibly highworld inflation rate as is under a fixed

exchange rate. The free movement ofdemand and supply helps to insulatethe domestic economy from worldeconomic fluctuations.


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governments are free to choosetheir domestic policy as a floatingexchange rate would allow forautomatic correction of any balance

of payment disequilibrium thatmight arise from theimplementation of domestic policy.


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Cons of Floating Exchange Rate

unstable and uncertain under thefloating exchange rate regime.

Also, speculation tends to be higherin the floating exchange rate regime,hence leading to more uncertaintyespecially for traders and investors.

Fixed Versus Floating Exchange Rate

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