Evaluating The Merits And Demerits Of Fixed And Floating Exchange Rate Regimes

Currency exchange rates can be categorised as floating, in which case they constantly change based on a number of factors, or they can subsequently be fixed to another currency, where they still float, but they additionally move in conjunction with the currency to which they are pegged. Floating rates are a reflection of market movement, demonstrating the principles of both demand and supply, as well as limit imbalances in the international financial system. Fixed exchange rates are predominantly used by developing countries as they are preferred for their greater stability. They grant further control to central banks to set currency values, and are often used to evade market abuse. (MacEachern, A. 2008; Simmons, P.

There are many other factors influence the foreign exchange rate in a floating regime, for instance, expected interest rate parity and speculation, etc.

If a country has a fixed exchange rate, the country’s central bank must maintain the given price of the currency with that of the foreign currencies participating. If the central bank is unable to defend the currency during a speculative attack, they may be able to sell the currency in exchange for foreign currencies anticipating that when the bank runs out of reserves it will be forced to stop defending the currency at this price. If a speculator were to calculate correctly, the

OW does one determine whether a currency is fundamentally undervalued or overvalued? this question lies at the core of international economics, many trade disputes, and the new IMF surveillance effort. George Soros had the answer once—in 1992—when he successfully bet $1 billion against the pound sterling, in what turned out to be the beginning of a new era in large-scale currency speculation. Under assault by Soros and other speculators, who believed that the pound was overvalued, the British currency crashed, in turn forcing the United Kingdom’s dramatic exit from the european exchange Rate Mechanism (eRM), the precursor to the common european currency, the euro, to which it never

Essay question: History shows us that attempts to fix exchange rates or create monetary unions between different countries usually end in failure. Therefore, we should not be surprised by the current problems in the Euro Zone. Discuss

Russia used to pledge its nominal exchange rate with some main currencies such as US dollar. However, the Russian crisis has forced Russia to develop managed floating exchange rate system, where the exchange rate driven by market forces of the Ruble’s demand and supply with the help of government intervention. With this exchange rate, the government can ensure stability and predictability of ruble exchange rate and prevent abrupt fluctuation of the Ruble rate. Moreover, this system could achieve the target set of money supply growth, and further ensure that the economic agents comply with the Russian legislation regulating foreign exchange operation.

The economy in China has always been inspiring to me, how this country made all of this civilization and how this country used its economy to overcome the barriers which it faced by used lots of methods. One of these method is the ‘’Exchange Rate Issue’’ in general is the low value of your currency to increase the investments and therefore, will increase the rate of employment. So, an important determinant of foreign trade and foreign investment is the exchange rate. A low value of Chinese RMB makes Chinese exports cheaper and investment in China more attractive if the investment is to produce for export. Many countries in the world including those in the European Union, Japan and Taiwan, have adopted the flexible exchange rate system while China adopted a fixed exchange rate up to July 2005 but the government did change the fixed rate several times in the 1980s and early 1990s relative to the US dollar as its government deemed appropriate. Most recently the Chinese government has adopted a managed floating rate with the government deciding the rate around a small band daily relative to the value of a basket of foreign currencies but the basket is not explicitly specified. There are pros and cons of the fixed and the floating exchange rate systems. (See the Appendix for a more detailed discussion.) A fixed exchange provides an anchor for the government in the conduct of its monetary and fiscal policy. It limits the discretionary power of the government in the exercise of its

Also there is going to be less flexibility meaning it will be strenuous for the government to take action on temporary shocks, for example if there is an oil firm importing they are likely to be met with balance of payment deficit when there is an increase in the price for oil produce but if the fixed exchange rate is put in place it would be difficult to devalue the currency

The countries central bank maintains a fixed parity through direct intervention in the foreign exchange markets, for this reason the central bank must hold large reserves of foreign currency so as to mitigate the changes in supply and demand of their currency. If demand for a currency were to increase the exchange the central bank would have to sell enough of that currency in exchange for their own, to meet demand and maintain the exchange rate. A countries central bank is also able to maintain their exchange rate peg indirectly through the use of interest rate policy, imposition of foreign exchange regulations or intervention by other public institutions.

If the cost of maintaining the fixed system exceeds the benefit, government should not delay its review on the appropriateness of the exchange rate system, in order to reduce the risk of having a currency crisis similar to the Thailand 1997’s.

Since the volatility of floating rates causes costs for exports and imports. It also encourages international capital flows which can profit the welfare of a country. Especially in case of developing countries these capital flows can be very large. One big Problem of the exchange rate regimes is the loss of monetary and fiscal possibilities to stabilize the economy as well as Limitation of the ability to pursue domestic goals.

Exchange rates fluctuated as countries widely used “predatory” depreciations of their currencies as a means of gaining advantage in the world export market. Attempts were made to restore the gold standard, but participants lacked the political will to “follow the rules of the game”. The result for international trade and investment was profoundly detrimental.

Flexible exchange rates prevent many of these problems by providing less costly and more symmetric adjustment. Relative wages and prices can adjust quickly to shocks through nominal exchange rate movements in order to restore external balance. When the exchange rate floats and there is a liquid foreign exchange market, reserve holdings are seldom required.3 Most fundamentally, floating exchange rates overcome the seemingly innate tendency of countries to delay adjustment.

A country using the floating rate of exchange for its monetary allows its money to be traded in the money market at exchange rates fixed by the daily forces of demand and supply for such money. The monetary unit is allowed to seek its own price level.

Some researchers have studied the relationship between interest rates and exchange rates in the wider international crisis. In this context, Goldfajn and Gupta (1999) examined 80 episodes of currency crises between 1980 and 1998. By using a fixed-effects panel regression they concluded that the increase in interest rates related to the appreciation of the nominal exchange rate. They