Question

What are a fixed exchange rate and a floating exchange rate? Please explain in eextensive detail and provide and example for both detail. So I may understand thoroughly.

Answer 1

Fixed exchange rate also known as pegged exchange rate is established when currency of country is benchmarked against a currency or a basket of currencies. This system is achieved by the federal reserve bank of the country which follows a monetary policy to fix the exchange rate. This can be done by increasing or decreasing the interest rate or by buying or selling the domestic currency in the market. This helps in reducing the uncertainties of fluctuation and hence encourages trade and commerce.
E.g. The Chinese Yuan (or Renminbi) is pegged to the U.S. dollar.

Floating exchange rate is determined by the market forces of demand and supply. Here the banks don’t intervene rather the market forces determine the exchange rate. In floating exchange rate central banks intervene to reduce inflation and not for exchange rate. It is self-correcting. If exchange rate of currency depreciates than the imports become costlier and exports get extra benefits and vice versa.

E.g The US dollar, Indian INR,etc are floating rates