There are many possible exchange rate systems that can be employed by nations of the world. • What are the advantages and disadvantages of the currently dominant floating exchange rate system? • What alternative system(s) might be better suited to manage the present world economy? Justify your position through a thoughtful discussion that draws upon the readings and lectures for this week. In addition, you should seek out a timely and relevant external information source, such as an article from a reputable news provider like The Wall Street Journal or The Financial Times.
Student 1:
The advantages will that the floating exchange rate has an automatic stabilization. This is a situation whereby the disequilibrium found in the BOP determines the change that would be in the system. Freeing internal policy is also among the merits of floating exchange rate. External prices would be the determinant that pertains prevailing floating exchange rate as well as in the end, this would make the balance of payment to have a deficit. Therefore, this is an indication that the dominant floating ERS permits the running organization or government to carry on the internal policy objectives. Thirdly, the dominant floating exchange rate system permits the entire country to avoid inflation. This helps the country to focus on the payment surplus and the floating exchange rate so that the imports could not cause inflation. Finally, the prevailing floating exchange rate helps in lowering reserves (Schembri, 2019). The reserves are used to develop the economy so that the importation of capital goods would bring out economic growth.
The first disadvantage is lack of investment in the floating ERS. Therefore, lack of investment is brought about by the ability created which discourages the direct investment through floating exchange rate. Secondly, there is uncertainty in trade after the introduction of exchange rates. An example of this is when the seller is not the profits he or she will attain when the products are sold abroad. Thirdly, the fluctuations in the floating exchange rate may bring out speculations. The speculative movements of a country’s currency may be a cause of changes in the exchange rate. Finally, the dominant floating exchange rate may make a country to be ignorant, and this shows a lack of discipline because most states determine this after the floating exchange rate has caused awkward situations (Cao et al, 2020)
The entire world can use the free-market economic system to manage the economy. In this case, companies and people may be allowed to do business in the market in that they sell their products freely. Therefore, this would ensure enough profits that would encourage the introduction of many enterprises. The world can also focus on a mixed market system whereby the issue of capitalism and communism is not focused upon (Timm et al, 2016). This would allow the government-owned enterprises and privately-owned enterprises to work together to ensure economic growth.
Student 2:
Advantages and Disadvantages of Floating Exchange Rate System:
Advantages:
Inflationary Hedging – In a fixed system, if inflation were occurring in a country where trade is common, the home country would be paying more for imports.
Automatic Stabilization – Supply and demand factors dictate the exchange rates and therefore active management is not required to sustain the system. This can also help to avoid crises as external control in a fixed system may result in miscalculations.
Governmental Freedom to pursue other objectives – Because currency exchange rates automatically stabilize, government resources can be allocated to pressing matters such as employment rates.
External Value Manipulation – Governments have the capability to manipulate the value of their currency to their home country advantage.
Highly Flexible – Responds quickly to ever-changing global trading conditions.
Lower Reserves – No requirement for large reserves allows for better use of available liquid capital.
Disadvantages:
Speculation – Speculative sizable investments can impact currency values (negatively and positively) resulting in more aimless fluctuations in exchange rates.
Lacks Management – Short term problems could turn into long term problems when exchange rates are not actively managed/adjusted. This could result in economic disasters or curtail economic recoveries.
Exchange Rate Risks – The inherent uncertainty related to exchanges made internationally could deter MNCs from participating in international transactions or participating in direct foreign investments.
An Alternative System:
A shared global economic union would be a superior method to support international trade. Through currency integration, we remove foreign exchange rate risks associated with volatility and uncertainty. It also reduces trading costs and encourages the removal of trade barriers and taxes. Cost reduction will encourage greater competitiveness and increase product quality. Economies of scale as a result of lower costs should also lower prices and raise the standard of living, especially in places like China where the currency is purposely depreciated.
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