Advantages And Disadvantages Of Flexible Exchange Rate System Pdf

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advantages and disadvantages of flexible exchange rate system pdf

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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.

Flexible Exchange Rate System: Advantage and Disadvantage

Flexible exchange rate system is claimed to have the following advantages:. Under flexible exchange rate system, a country is free to adopt an independent policy to conduct properly the domestic economic affairs. The monetary policy of a country is not limited or affected by the economic conditions of other countries.

A fluctuating exchange rate system protects the domestic economy from the shocks produced by the disturbances generated in other countries. Thus, it acts as a shock absorber and saves the internal economy from the disturbing effects from abroad. The flexible exchange rate system promotes economic development and helps to achieve full employment in the country.

The exchange rates can be changed in accordance with the requirements of the monetary policy of the country to achieve the planned national objectives. The system of flexible exchange rates automatically removes the disequilibrium in the balance of payments.

As a result, exports are encouraged, and imports are discouraged thereby, establishing equilibrium in the balance of payment. The system of flexible exchange rates does not permit exchange control and promotes free trade.

Restrictions on international trade are removed and there is free movement of capital and money between countries. The system of flexible exchange rates eliminates the need for official foreign exchange reserves, if the individual governments do not employ stabilization funds to influence the rate. Thus, the problem of international liquidity is automatically solved.

In fact, the present shortage of international liquidity is due to pegging the exchange rates and the intervention of the IMF authorities to prevent fluctuations in the rates beyond a narrow limit. Under the flexible exchange rate system, the foreign exchange rates are determined by the market forces of demand and supply.

Market is cleared off automatically through changes in exchange rates and the possibility of scarcity or surplus of any currency does not exist. International Trade not Promoted by Fixed Rates:. The argument that fixed exchange rates promotes international trade is not supported by historical facts of inter-war or post-war period.

On the other hand under the flexible exchange rate system, the trend of the rate of exchange is generally assessed through the forward market, and the traders are protected from financial losses arising from fluctuating exchange rates. This helps in promoting international trade.

International Investment not Promoted by Fixed Rates:. The argument that long-term international investments are encouraged under fixed exchange rate system is not valid. Both the lenders and borrowers cannot expect the exchange rate to remain stable over a very long-period.

This stable exchange rates are not necessary for any system of currency areas. The sterling block functioned smoothly during the thirties in spite of the fluctuating rates of the member countries. The main weakness of the stable exchange rate system is that in spite of the strict exchange control, currency speculation is encouraged. This destroys the stability in the exchange value of the home currency and makes devaluation of the currency inevitable.

For instance, the pound had to be devalued in mainly because of such speculation. The following are the main drawbacks of the system of flexible exchange rates :. The elasticities in the international markets are too low for exchange rate, variations to operate successfully in bringing about automatic equilibrating adjustments. Hence, the depreciation of the weak currency would simply tend to worsen the balance of payments deficit further.

Flexible exchange rates create conditions of instability and uncertainty which, in turn, tend to reduce the volume of international trade and foreign investment. Long-term foreign investments arc greatly reduced because of higher risks involved.

The system of flexible exchange rates has serious repercussion on the economic structure of the economy. Fluctuating exchange rates cause changes in the price of imported and exported goods which, in turn, destabilise the economy of the country. The system of fluctuating exchange rates leads to unnecessary international capital movements.

By encouraging speculative activities, such a system causes large-scale capital outflows and inflows, thus, seriously disturbing the economy of the country. Depression Effects of Capital Movements:. In a situation of high liquidity preference, people tend to hoard currency, interest rates rise, investment falls and there is large-scale unemployment in the economy.

Flexible exchange rate system involves greater possibility of inflationary effect of exchange depreciation on domestic price level of a country.

Inflationary rise in prices leads to further depreciation of the external value of the currency. The immobility of various factors of production deprives the flexible exchange rate system of its advantages arising from the adoption of monetary and other policies for maintaining internal stability. Such policies produce desirable effects on production and employment only when supply of factors of production is elastic.

Experience of the flexible exchange rate system adopted between the two world wars has shown that it was a flop. What are the main advantages and disadvantages of Fixed Exchange Rates? What are the objectives of World Bank?

International economics

A fixed exchange rate , sometimes called a pegged exchange rate , is a type of exchange rate regime in which a currency 's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies , or another measure of value, such as gold. There are benefits and risks to using a fixed exchange rate system. A fixed exchange rate is typically used to stabilize the exchange rate of a currency by directly fixing its value in a predetermined ratio to a different, more stable, or more internationally prevalent currency or currencies to which the currency is pegged. In doing so, the exchange rate between the currency and its peg does not change based on market conditions, unlike in a floating flexible exchange regime. This makes trade and investments between the two currency areas easier and more predictable and is especially useful for small economies that borrow primarily in foreign currency and in which external trade forms a large part of their GDP. A fixed exchange rate system can also be used to control the behavior of a currency, such as by limiting rates of inflation. However, in doing so, the pegged currency is then controlled by its reference value.

Advantages of fixed exchange rates

Skip to search form Skip to main content You are currently offline. Some features of the site may not work correctly. DOI: The choice of an adequate exchange rate regime proves to be a highly sensitive field within which the economic authorities present and confirm themselves. View via Publisher.

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.

Unlike fixed exchange rates, these currencies float freely, that is, unrestrained by government controls or trade limits. In consequence, floating exchange rates are in continuous fluctuation. Changes in factors such as interest rates, inflation, political stability, trade flows, tourism and speculation, just to name a few, maintain free-floating currencies in continuous movement. This volatility is perceived as a positive aspect for currency speculators, who account for the vast majority of FX market trading.

Fixed versus Flexible Exchange Rates: The Everlasting Debate

Flexible exchange rate system is claimed to have the following advantages:. Under flexible exchange rate system, a country is free to adopt an independent policy to conduct properly the domestic economic affairs. The monetary policy of a country is not limited or affected by the economic conditions of other countries.

Exchange Rate Regime Choice

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.

The central bank of a country remains committed at all times to buy and sell its currency at a fixed price. The central bank provides foreign currency needed to finance payments imbalances. What are the main advantages and disadvantages of Fixed Exchange Rates? Advantages of Fixed Exchange Rates The main arguments advanced in favor of the system of fixed or stable exchange rates are as follows: 1. Promotes International Trade: 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.

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Therefore, the post–Bretton Woods era starting in with its fiat currency and flexible exchange rates is no stranger to the international monetary system.


What Are the Main Advantages and Disadvantages of Fixed Exchange Rates

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4 Comments

  1. Rudecindo R. 06.01.2021 at 02:16

    Let us make an in-depth study of the advantages and disadvantages of the flexible exchange rate system. Advantages: (i) Automatic Adjustment in BOP.

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  3. Verna E. 08.01.2021 at 10:12

    Let us make an in-depth study of the advantages and disadvantages of the flexible exchange rate system.

  4. Melisande B. 12.01.2021 at 06:22

    International economics.