Question

Low-income nations have a dilemma as to whether to fix or float the currency exchange rates. There are many factors that affect their decisions and how effectively they can manage a financial system. Discuss a few of these factors that contribute to the success of a policy.

Answer 1

A Fixed exchange rate is set by the monetary authority of the economy given the exchange rates of other countries. While the floating exchange rate is determined by the demand and supply conditions in the for exchange market.

In case of low income countries, fixed exchange rate is a good decision because it would stable the trade ie the imports and exports and hence there will be credibility established. It also reduces the uncertainty of The foreign exchange market. Also there is more intervention by the government or monetary authority to keep the rate fixed which might lead to draining of the foreign reserves etc.

In case of floating exchange, there is more autonomy of the monetary policy because of which the economy can easily come out of recession and this could also reduce the impact of the economic shocks. Another factor of floating exchange is that since the government does not fix it it can focus and maintain the interest rate and stabilise the level of output.

Given the benefits and drawbacks of both of them, the economy could work according to the persisting condition in the economy. Also now there exists managed floating rate which is floating rate partially managed by the monetary authority and this is commonly being used by the low income countries.

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