Flexible
Exchange Rate System
Exchange
rate systems are classified according to the degree to which the rates are
controlled by the government. They fall into the following categories: Fixed, Flexible,
Managed float and Pegged (Steinberg & Malhotra, 2014).
In this case, focus is on the flexible and fixed exchange rate systems.
Flexible
exchangerate refers to the exchange rates that are freely determined by the
market forces i.e. the forces of demand and supply. The advantages of flexible
exchange rates are:
Individual country is insulated
against the economic problems of the other countries. Therefore the problem
such inflation, unemployment of one country does not affect the operations of
the country.
Under this exchange
rate, the central bank interventions are not needed that may affect the economy
unfavourably.
Third, the government are
not restricted to the exchange rate boundaries when setting new boundaries.
Finally, less capital
flow restrictions and therefore this enhances the efficiency of the financial
market.
The
disadvantages include:
The MNCs may need to
devote substantial resources in managing exposure to exchange rate
fluctuations.
The country that
experiences the economic problem may compound the problems more.
Fixed
Exchange Rate System
Fixed
exchange rate systems are held constant or allowed to fluctuate only within
very narrow bands. They came into existence during the Breton wood era (1944-1971)
that fixed the exchange rates in terms of gold. Around 1971, the Smithsonian
agreement that followed merely adjusted the exchange rates and expanded the
fluctuation boundaries. The advantages of the fixed exchange rate systems are
that it makes it easier the work of the multinational corporations(Williamson, 2014).
However, the disadvantages of this system are that government may revalue their
currencies. In fact, the dollar had been revalued more than once when the US
experience balance of trade deficit. Second, each country becomes vulnerable to
the economic conditions in other countries. Example for a fixed exchange rate
system is that US dollar was linked to gold in around 20th century.
This was referred to as gold standard.
Indeed, there
are 116 separate cases where the exchange rate fell more than 25 per cent
within the year between 1975 and 1996. Most of these were under the flexible
regimes. In 1973, there were changes in the pattern of the world trade and
world economics due to OPEC oil shock. Therefore, fixed exchange rate would
have caused major problems (Edwards, 2015).
References
Edwards, S. (2015). Monetary Policy
Independence under Flexible Exchange Rates: An Illusion.The World Economy.
Steinberg, D. A., &Malhotra, K.
(2014). The Effect of Authoritarian Regime Type on Exchange Rate Policy.World
Politics, 66(03), 491-529.
Williamson, J. (2014). The future
exchange rate regime.PSL Quarterly Review, 28(113).
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