Question

Expilcate how the exchange rates , in a exchange rate regime and in a fixed exchange rate world, are affected by deficits and surpluses. 300 words

Answer 1

>> Fixed Exchange rate world is a regime where government or central bank that ties the country's currency exchange rate to another country's currency or the price of gold.

>> The intentions here is to keep value of currency in narrow band.

>> It will provide sense of certainty to exporter and importer and also helps government to maintain inflation at a lower level. It will keep interest rate down and stimulate investment and trade.

>> Developing nations use this to limit speculation and allowes trader to plan their trade without worrying.

>> To maintain this scenario central bank needs ot interven by buying and selling domestic currency.

>> So when evere there is excees demand of foreign currency on private forex at the fixed rate it will be deficit situation, so to satisfy central bank will sell all the forex reserve in order to maintain the fixed exchange rate.

>> When ever demand for foreign currency is lower, central bank will buy excess of foreign reserve to maintain the fixed exchange rate.

>> In Other words one can say that whenever central bank sells foreign currency demand for local currency decreases and when ever central bank buy foreign currency, demand for domestic currency increases.

>> To summarize this in economical terms, called as balance of payment.

>> When balannce of payment is in defict it means that there is excess demand for foreign currency and balance of payment surplus is lower demand of foreign currency.

Benifit:

>> Avoid Currency Fluctuation

>> Maintain Inflation

>> Devaluation prevented

>> Boost Investment and trade

Disadvantage:

>> Flexibility will not be there

>> Imbalnce in current account