Question

What are possible exchange rate regimes and what is the world’s most practiced regime currently and why (reasons)? Also discuss the pros and cons of each regime.

Answer 1

The Floating Exchange Rate- A floating exchange rate, or fluctuating exchange rate, is a form of exchange rate regime in which the value of a currency can fluctuate depending on the foreign currency. A currency in which a floating exchange rate is used is known as a floating currency. The dollar is a case in point for a floating currency.

Most economists assume that floating exchange rates are the best exchange rate system possible, since they automatically adapt to economic circumstances. Such regimes allow a country to dampen the effect of shocks and international business cycles, and to mitigate the risk of a crisis of payments in the balance. But they also generate unpredictability as a result of their dynamism

No need for international exchange rate management: Unlike fixed exchange rates based on a metallic standard, floating exchange rates do not need an international manager like the International Monetary Fund to look into current account imbalances. If a nation has significant current account deficits under the floating system the currency depreciates.
Usage of limited capital to forecast exchange rates: Higher exchange-rate volatility raises the exchange-rate risk faced by financial market participants. Therefore, in an attempt to mitigate their exposure to exchange rate risk, they are allocating significant resources to forecast changes in the exchange rate.

The Fixed Exchange Rate- A fixed exchange rate system, or fixed exchange rate system, is a system of currency in which governments agree to preserve a currency value that is constant against a specific currency or nice. In a fixed exchange-rate system, the government of a nation determines the value of its currency in terms of either a fixed weight of an asset, another currency, or other currency basket. One country's central bank remains committed to purchasing and selling its currency at a set price at all times.

Providing greater security for importers and exporters, thereby promoting further trade and investment globally.
Helping the government hold inflation down, which can have beneficial long-term consequences such as holding interest rates down.
Preventing currency changes which become undervalued or overvalued.
Limiting the degree to which central banks are able to change economic growth interest rates;

The Pegged Float Exchange Rate- Pegged floating currencies are connected to a band or value that is either set, or changed periodically. They are a combination of rotating and fixed regimes

The greatest advantages stem from the impact it has on exports and trade in a region, particularly between a nation with low cost of production and another region with a stronger currency. A wealthier, more developed nation can prefer to produce its products in a less developed country where the cost of production is smaller. When those less mature nations translate their earnings into their domestic currencies, they make a larger profit, creating a win/win situation for both countries.

Among the drawbacks is the significant amount of reserves that a central bank must hold in order to operate a pegged exchange rate. Such large reserves can cause higher inflation, leading to rising prices, causing problems for economic stability in a country. The central bank must also buy or sell its currency on the open market, in order to preserve its value in line with the currency of the pegged country.