A fixed exchange rate would have caused major problems at this time as some countries would be uncompetitive given their inflation rate. It is not possible for economists to reach a particular conclusion, so the debate is indecisive, as counter arguments keep coming from both regimes. Of course, such foreign investment having multiplier effect leads to higher economic growth. However, central banks cannot increase their gold reserves as their economies grow. In other words, the fixed exchange rate system fails to gloss over the international competitive environment. In case of fixed exchange rates, the Central banks of different nations have to act in tandem. A fixed, or pegged, rate is a rate the government central bank sets and maintains as the official exchange rate.
Conclusion As both the exchange rate system have their positive and negative aspects. The floating exchange rate might worsen existing levels of inflation. This will drive the value of the Kwacha down. The conditions may even get worse because of expensive imports. If a country has rising inflation and a tendency toward external deficit, the depreciation of the currency can intensify the inflation pressures in the country. Instead, such a system forces the government to undertake correction through increasing interest rates and reducing domestic demand. To maintain a fixed level of the exchange rate may conflict with other macroeconomic objectives.
As of December 2010, China's consumer had moved to around 5%. Possible advantages of a low exchange rate involve the greater employment in export industries as exports become relatively less expensive. Conversely, in the floating exchange system, countries that experience high inflation merely devalue, and thus there is little anti-inflation restraint. As its name suggests, it is a rate at which the currency of one country can be exchanged converted for another. Under the circumstance, speculators go on buying home currencies where exchange rates have been reduced.
However, these risks can be managed with tools like hedging. Disadvantages The freely floating currency system also has its critics. There are no right or wrong answers. For example the price for imported raw materials becomes cheaper; the cost of production for firms becomes less. Fixed Exhange-Rate System: currency system in which governments try to keep the values of their currencies constant against one another Flexible Exchange- Rate System: allows the exchange rate to be determined by supply and demand. It's an attempt to lower the. While flexible exchange rates can ensure that the country achieves external balance, they do not ensure internal balance.
Speculative Capital Flows It was thought that speculation would inevitably create unworkable volatility and destabilize a flexible, or freely floating, exchange rate. This is a reserved amount of foreign currency held by the central bank which it can use to release or absorb extra funds into or out of the market. While theoreticians are favours flexible exchange rate due to their reliance on the free market system and price mechanism, policy makers, and central bankers supported fixed exchange rate system. Under the circumstance, speculators go on buying home currencies where exchange rates have been reduced. Floating exchange rates provide freedom in terms of domestic economic policy since the central bank is not forced to meet a certain exchange rate by using interest rate which if used for another purpose might undermine the entire purpose of using fixed rate.
Since there is the central bank assurance, less speculation goes on. Another way of controlling exchange rate is to use foreign currencies. Any undue fluctuations in exchange rate cause problems to the plans and programmes of both exporters and imports. Export industries might be damaged. Flexible Disadvantages Floating exchange rates tend to create uncertainty on the international markets.
Advantages of Pegged exchange rate — Advantages of pegged exchange rates include a reduction in the volatility of the exchange rate at least in the short-run and the imposition of some discipline on government policies. First of all, you need to know what exchange rate is? A common element with all fixed or pegged foreign exchange regimes is the need to maintain the fixed exchange rate. Disadvantages: i Speculation Encouraged: In fact, uncertainty and, hence, speculative activities, tend to get a boost even under the fixed rate system. Since fixed rate system is ensured against something else stable ie. In this system, the currency price is market determined, concerning other currencies, i. Very common Self-adjusting mechanism Operates through variation in supply of money, domestic interest rate and price. There are two ways the price of a currency can be determined against another.
In conclusion, fixed exchange rate offers stability and may even enhance tourism as tourists visiting from other nations can budget beforehand as they know what their will be worth. Further, the risks associated with international trade and investment get minimised largely, if exchange rates are not allowed to vary. In consequence, this really restrains the domestic financial polices making sure that they do not focus on inflation and unemployment. Saudi Arabia did that because its primary export, oil, is priced in U. It is similar to the fixed rate system in that governments can and sometimes do intervene to prevent their currencies from moving too far in a certain direction. Several stopgap measures were taken but uncertainty and confusion in exchange rate system continued.
A government has to maintain high levels of foreign reserves to keep the exchange rate fixed as well as to instill confidence on the foreign exchange markets. In a world of free fluctuating exchange rate the danger of the flight of capital is rather high as this kind of exchange rate induces people to speculate. Such a situation can be prevented by making the exchange rate fixed. Thus, fixed exchange rate—in the ultimate analysis—go for currency depreciation that results in lower economic growth and higher unemployment coupled with high inflation—the two most undesirable and unpleasant macro- economic variables not liked by anyone. Inherent Instability Fixed rates do not automatically harmonize different domestic economic policies that differ between countries. This can be prevented by the stable exchange rate.
Although this criticism is valid, it could apply as well to the fixed exchange rate system, where governments have the power to devalue their currencies. Further, as stability in the exchange rate over longish periods eliminates the threat of speculation, it discourages flight of capital. A fixed exchange rate provides greater certainty and encourages firms to invest. Furthermore, in reality, floating exchange rates are affected by many factors, not only demand and supply. However, in the long run, this allocation seems to be ad-hoc since it does not follow any given plan. Hence, if there is likelihood that the monetary policy may be misused for personal gains by a group of influential people, then it is better to peg the currency to another more developed currency.