There may be selection of exchange rate systems (types) in the international exchange market. Its two broad varieties or systems are resolved Exchange Rate and also Flexible Exchange price as defined below.

You are watching: Difference between fixed and flexible exchange rates

In between these two extreme rates, there are some hybrid systems favor Crawling Peg, regulated Floating.


Broadly when government decides the switch rate, that is referred to as fixed exchange rate. ~ above the various other hand, as soon as market forces determine the rate, the is referred to as floating exchange rate.

(a) Fixed Exchange rate System:

Fixed exchange rate is the price which is officially fixed by the federal government or financial authority and not figured out by sector forces. Just a very little deviation indigenous this fixed value is possible. In this system, foreign central banks stand ready to buy and sell their currencies at a fixed price. A typical kind of this system was supplied under yellow Standard mechanism in i m sorry each country committed itself to transform freely its currency into yellow at a resolved price.

In other words, worth of each money was characterized in terms of gold and, therefore, exchange rate was fixed according to the gold worth of currencies that have to be exchanged. This was called mint par worth of exchange. Later on Fixed Exchange Rate system prevailed in the people under an commitment reached in July 1994.

The advantages and defect of this device are as under:


Merits:

(i) it ensures stability in exchange price which encourages foreign trade, (ii) that contributes to the coordination the macro policies of nations in an interdependent world economy, (iii) solved exchange price ensures that major economic disturbances in the member nations do not occur, (iv) It avoids capital outflow, (v) fixed exchange rates are an ext conducive to growth of people trade because it prevents risk and also uncertainty in transactions, (vi) It avoids speculation in international exchange market.

Demerits:

(i) fear of devaluation. In a situation of overabundance demand, central bank supplies its reserves to maintain foreign exchange rate. But when reserves room exhausted and also excess demand still persists, government is compelled to devalue residential currency. If speculators believe that exchange price cannot be hosted for long, they buy international exchange in huge amount causing deficit in balance the payment. This might lead to larger devaluation. This is the key flaw or demerit of fixed exchange price system, (ii) benefits of free markets space deprived; (iii) over there is always possibility that under-valuation or over-valuation.

(b) Flexible (Floating) Exchange rate System:

The system of exchange price in which rate of exchange is figured out by pressures of demand and also supply of international exchange sector is called Flexible Exchange price System. Here, value of money is enabled to shake or readjust freely follow to change in demand and also supply of foreign exchange.

There is no official intervention in international exchange market. Under this system, the main bank, there is no intervention, permits the exchange price to change so as to equate the supply and demand for foreign money In India, the is versatile exchange rate which is being determined. The international exchange market is liven at all times by transforms in the exchange rate. Advantages and flaw of this device are noted below:

Merits:

(i) Deficit or surplus in BOP is immediately corrected, (ii) over there is no need for federal government to hold any type of foreign exchange reserve, (iii) It helps in optimum resource allocation, (iv) the frees the federal government from difficulty of BOP


Demerits:

(i) It motivates speculation causing fluctuations in international exchange rate, (ii) wide fluctuation in exchange price hampers international trade and capital movement between countries, (iii) that generates inflationary pressure as soon as prices that imports go up as result of depreciation that currency.

Managed Floating:

This describes a device of gradual adjustments in the exchange rate deliberately make by a central bank to affect the worth of that is own money in relation to various other currencies. This is done to conserve its own currency from short-lived volatility in exchange rate brought about by economic shocks and speculation. Thus, main bank intervenes to smoothen out ups and downs in the exchange price of home money to its own advantage.

When central bank manipulates floating exchange rate to disadvantage of other countries, the is termed as dirty floating. However, main banks have no solved times for intervention but have a set of rules and guidelines because that this purpose.

See more: Convert Gallons Per Minute To Million Gallons Per Day To Us Gallons Per Minute

(c) distinction between addressed Exchange Rate and also Flexible Exchange price :

Fixed exchange price is the price which is officially fixed in regards to gold or any other currency by the government. It does not change with adjust in demand and also supply of foreign currency. As versus it, functional exchange price is the price which, prefer price the a commodity, is determined by pressures of demand and supply in the foreign exchange market. It changes according to readjust in demand and supply of international currency. There is no government intervention.


Related Articles


Difference between Spot Market and also Forward market |Foreign Exchange
Notes on Balance of Trade and Balance the Payment | Micro business economics
*

Welcome to gaianation.net! our mission is to provide an virtual platform to aid students to discuss anything and everything around Economics. This website consists of study notes, research papers, essays, articles and also other allied information submitted by visitors choose YOU.