File Name: advantages and disadvantages of fixed exchange rate .zip
The freely floating currency system is the predominant system of foreign exchange that is prevalent in the world today. As globalization has progressed, more countries have abandoned their currency pegs and have allowed their currencies to freely float. Some have been forced to do so by market participants whereas others have made their choice in the light of the advantages that this system has to offer. In this article, we will have a look at the advantages and disadvantages that are faced by any country when it adopts a floating exchange rate regime. Market Determined Rates: Freely floating exchange rate means that the market will determine the rate at which one currency can be exchanged for another. The market will set these rates on a real time basis as and when new information flows in. This reduces the need for an elaborate mechanism to ensure that the exchange rates remain within a particular range.
Crawling peg is an exchange rate regime that allows depreciation or appreciation to happen gradually. It is usually seen as a part of a fixed exchange rate regime. The system is a method to fully use the key attributes of the fixed exchange regimes as well as the flexibility of the floating exchange rate regime. The system is shaped to peg at a certain value but at the same time is designed to "glide" to respond to external market uncertainties. To react to external pressure such as interest rate differentials or changes in foreign-exchange reserves to appreciate or depreciate the exchange rate, the system can have moderately-sized, frequent exchange rate changes to ensure that the economic dislocation is minimized. Some central banks use a formula that triggers a change when certain conditions are met, while others prefer not to use a preset formula and frequently change the exchange rate to discourage speculations.
The main arguments advanced in favor of the system of fixed or stable exchange rates are as follows:. Fixed or stable exchange rates ensure certainty about the foreign payments and inspire confidence among the importers and exporters. This helps to promote international trade. Fixed exchange rates are even more essential for the smaller nations like the U. Fluctuating exchange rates will seriously affect the process of economic growth in these economies. Fixed exchange rates promote international investments.
(i) Elimination of Uncertainty and Risk: (ii) Speculation Deterred: (iii) Prevention of Depreciation of Currency: (iv) Adoption of Responsible Macroeconomic Policies: (v) Attraction of Foreign Investment: (vi) Anti-inflationary: (i) Speculation Encouraged: (ii) Adequacy of Foreign Exchange Reserves.
Let us make an in-depth study of the advantages and disadvantages of the fixed exchange rate system. The necessary condition for an orderly and steady growth of trade demands stability in exchange rate. Any undue fluctuations in exchange rate cause problems to the plans and programmes of both exporters and imports.
Fixed exchange rate systems were common during the first half of the 20th century. They were strongly favored by governments, since they were mistakenly believed to offer three key advantages. First, they would lower the risk of speculative capital flows that could destabilize the economy.
International economics. Table of Contents Topic pack - International economics - introduction Terms and definitions Games and activities International Organisations Section 4. 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.
A fixed exchange rate occurs when a country keeps the value of its currency at a certain level against another currency. Often countries join a semi-fixed exchange rate, where the currency can fluctuate within a small target level. Avoid currency fluctuations. If the value of currencies fluctuates, significantly this can cause problems for firms engaged in trade. Stability encourages investment.
International Finance pp Cite as. Prior to the move to generalized floating in , the adoption of floating exchange rates had long been advocated by eminent economists such as Milton Friedman , Egon Sohmen and Harry Johnson However, the experience with floating rates has not been the panacea that many advocates had presupposed and this has led many economists to propose schemes designed to limit exchange-rate flexibility. Unable to display preview. Download preview PDF.
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