As this would have a deflationary effect on the economy the demand might decrease and unemployment might increase. This is because the monetary policy that they set could influence or be influenced by the economic conditions of member nations. The advantages of this are that the float attempts to combine both the fixed and flexible exchange rate systems, depending on the instability. Second, I will compare the two types in this dissertation. Under a flexible exchange rate regime, expansionary or contractionary monetary policies can address recessionary or inflationary pressures, respectively.
A central bank will often then be forced to revalue or devalue the official rate so that the rate is in line with the unofficial one, thereby halting the activity of the black market. Emerging markets and exchange control 3 4. Bretton Woods system, Central bank, Currency 2472 Words 8 Pages neither fixed nor flexible exchange rate system. Another advantage is that reserves are not used to control the value of the currency. Inventory, Inventory control system, Supply chain management 1813 Words 7 Pages Fixed versus floating exchange rates Introduction The exchange rate regime The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market.
Investment and trade may be adversely affected. Exchange rates can be fixed or floating and this article will tackle the latter including its pros and cons. A possible disadvantage of a low exchange rate is inflation, defined as the sustained increase in the general or average level of prices. First, I will describe exchange rates. The floating rate allows governments freedom to pursue their own internal policy objectives such as growth and full employment without external constraints.
Advantages of Fixed Exchange Rate System — 1. Fixed exchange rates require the Central Banks to set up trading desks and currency boards to manage the currency actively on a daily basis. Possible advantages of a low exchange rate involve the greater employment in export industries as exports become relatively less expensive. Disadvantage of Flexible Exchange Rates The following are the main drawbacks of the system of flexible exchange rates : 1. A country is more insulated from unemployment problems in other countries.
Also, currencies can be forced out of the fixed exchange rate — undermining its supposed benefits. By: Jane Doe Eco 500 In this paper, I am going to discuss and compare exchange rates. 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. Why do you think Central Banks might prefer a managed exchange rate system over a fixed or a floating exchange rate? A fixed system forces a government to correct the disequilibrium by raising interest rates and lowering domestic demand. Business dictionary defines an exchange rate as the rate at which one currency can be exchanged for another.
Also, since Forex market is not regulated, currency values could skyrocket or hit rock bottom in a matter of minutes. If the exchange rates are fluctuating, the lenders and investors will not be prepared to lend for long-term investments. Solutions to Balance of Payment Problems: The system of flexible exchange rates automatically removes the disequilibrium in the balance of payments. For instance, when the dollar raises its interest rates, all currencies pegged to it also have to make necessary changes. There are two ways the price of a currency can be determined against another. It can do this by buying sterling but this is only a short-term measure. Firms will be able to plan ahead, knowing that the predicted costs and prices for international trading agreements will not change.
Inflationary Effect: Flexible exchange rate system involves greater possibility of inflationary effect of exchange depreciation on domestic price level of a country. For many years a fee for service system was in place. Setting the level of the fixed exchange rate is not simple. This uncertainty can be reduced by hedging the foreign exchange risk on the forward market. On the other hand your imports will become expen … sive since you'll have to pay more of your currency to buy their currency. How does this influence commodity currency? In a system of flexible exchange rates, the liquidity preference is high because the businessmen will like to enjoy wind fall gains from the fluctuating exchange rates. The firm's exposure to exchange rate risk increased.
These reserves have an opportunity cost in the form of foregone financial return. Free floating exchange rate is determined by the interaction of currency supplies and demands with no government intervention. But, if you ever do need it, you are ever so glad you did. Brought to you by No Exchange Rate Risk A fixed exchange rate removes the risk of exchange rate changes. Managed Float Exchange Rate System — The exchange rate system that exists today for most currencies lies somewhere between fixed and freely floating.
This means you have just been affected by the exchange rate. You must have some kind of project management to deliver any project, small or big. Fiscal policy tends to be weaker. Shock Absorber: A fluctuating exchange rate system protects the domestic economy from the shocks produced by the disturbances generated in other countries. Lack of Investment: The uncertainty introduced by floating exchange rates may discourage direct foreign investment i. This should reduce the negative impact of any external shocks.