Question

Explain the features of floating exchange rates superior to those of fixed exchange rates. Discuss the effects of the Bretton Woods System for floating exchange rates.

Answer 1

FEATURES OF FLOATING EXCHANGE RATES SUPERIOR TO THOSE OF FIXED EXCHANGE RATES:

i) Unlike fixed exchange rate system wherein government entirely determines the rate, flexible exchange rate is a regime under which country's currency is set by the demand and supply in the forex market relative to other currencies.

ii) In case of floating exchange rates, monetary and fiscal authorities are free to persue their internal goals and exchange rate adjustment works as an automatic stabilizer to promote these goals.

iii) Floating exchange rate tend to reflect more fairly and accurately the true value of the currency but is also more volatile than the fixed exchange rates.

iv) Under floating exchange rates, there is no need for international management of exchange rates. There is also no requirement for an international manager to look over current account imbalances.

EFFECTS OF BRETTON WOODS SYSTEM FOR FLOATING EXCHANGE RATES

i) The rules of Bretton woods system included a system of fixed exchange rates rather than floating exchange rates. The rules also set to encourage an open system with the convertibility of their respective currencies into other currencies and to the free trade.

ii) This was called as "pegged rate" currency regime in which members of the countries were required to establish a parity of their national currencies in terms of the reserve currency i.e. a peg. It was also reqired to maintain the exchange rate within 1 percent of the parity always.