Floating Exchange Rate

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Nations which harbor excellent fiscal policy designers should opt for a flexible exchange rate system. Nations, however, which do not have such policy makers should opt instead for a fixed exchange rate system. When attempting to stabilize an economy, monetary policy is the most efficient weapon that policymakers possess (Weerapana, 2003). In other words, it is much simpler to enact monetary policy than fiscal (Weerapana, 2003). Some nations benefit from a fixed exchange rate system, however. Nations such as Brazil, Kenya and Turkey have been irresponsible in printing money; this leads to inflation (Weerapana, 2003). This leads to a steep rise in prices, and a subsequent devaluing of the currency. A fixed exchange rate will, for these nations, neutralize the central bank (Weerapana, 2003). Fiscal policy is not as much of a consideration in determining an exchange rate system. It is simply too unwieldy an instrument. Flexible exchange rates can contribute to greater uncertainty for traders, since fluctuations can lead to differences in remunerative value, between when the deal was made, and when payment is made (Tornell and Velasco, 1995). In a fixed system, importers and exporters don’t have to worry about such fluctuations. But when monies spent are excessive, nations may be forced to devalue currency quite often; hence, there might not be the exchange rate stability in a fixed system that one perceives (Tornell and Velasco, 1995). Considering balance of payment, it is important to note that under a fixed system it is likely that poor management can lead to a current account deficit very much larger than capital account surplus (Weerapana, 2003). Without proper reserves, such a situation might lead to crisis, and even bailout. Under flexible exchange, no bailout or crisis would ever occur. Balance of payment deficits would lead to exchange rate depreciation (Weerapana, 2003). In terms of external shocks to the economy, flexible rates are...
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