Fixed versus floating exchange rates
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. Each country has its exchange rate policy which determines the form of a government influence on the currency exchange rate.
There are three main type of the exchange rate regime:
• a floating exchange rate, where the market dictates the movements of the exchange rate,
• and the fixed exchange rate, which ties the currency to another currency,
• a pegged float, where the central bank keeps the rate from deviating too far from a target band or value, divides into 2 subtypes:
o Crawling bands: the rate is allowed to fluctuate in a band around a central value, which is adjusted periodically,
o Crawling pegs: the rate itself is fixed, and adjusted periodically.
I’m going to concentrate on the first two of exchange rate regimes.
The fixed exchange rate
A fixed exchange rate is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold. A pegged currency with very small bands is sometimes called as fixed one too. A fixed exchange rate is usually used to stabilize the value of a currency against the currency it is pegged to and it can also be used as a means to control inflation.
Advantages of fixed exchange rates
Predictability or even certainty.
The international trade and investments are easier and more predictable. If a company decides to export its goods outside the country or to import them it calculates the prices basing on current exchange rate. The fixed exchange rate ensures that present profitability calculation will be still valid in the future.
A currency speculation is sensible only if a speculator believes that the exchange rate of... [continues]
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