Question

What do you think are the pros and cons of the fixed exchange rate system? What do you think are the pros and cons of the floating exchange rate system? Which system do you think is better? Explain.

Your answer must have a minimum of 300 words. Your score is based on your explanation.

Answer 1

There are several pros and cons of Fixed exchange rate system that are discussed below:- The first advantage under fixed exchange rate is that it helps to avoid fluctuations in the currency of the nations. At the same time the fixed exchange rate system also helps in bringing stability in investment through eliminating uncertainties of exchange rate fluctuations. Thus it encourages firms to invest more. Apart from this a fixed exchange rate also expected to reduce the inflationary pressure

There are several disadvantages or cons associated with the fixed exchange rate system .The first disadvantage of the of fixed exchange rate system is that it lacks flexibility . It lacks flexibility necessary  to respond the temporary shocks the economy is facing . Another cons with this system is that it may lead to current account imbalances. As in a fixed exchange rate, there is no ability to devalue and reduce current account deficit. Under a fixed exchange rate system it is very difficult to know the right rate wgich can be fixed . This may lead to selection of a wrong rate. If the rate is very high, it will make exports uncompetitive on the other hand if the rate is too low, it may lead to inflation.

In  order to define a floating exchange rate system we can say that it is a system in which is the currency price of a country is set by the market (foreign exchange) which is based on supply and demand in relation to other nations currencies. This is in contrast to a fixed exchange where   the government is is responsible to determine or fix the exchange rate. Under floating exchange rate system in contrast to fixed rate there is no need of any kind of international management of of exchange rate. On the other hand under floating exchange rate system countries are more protected from the macroeconomic variables of the other country. In comparison of a fixed exchange rate system under floating exchange rate there is no need to uphold the parity so requires less central bank intervention. There are several cons with the floating exchange rate system like floating exchange rate may sometimes worsen the existing economic crisis and problems. It is also highly volatile in a way that under floating exchange rate high volatility in exchange rates results in expansion of  the exchange rate risk that financial market participants face.

Both systems have there advantage and disadvantages and both are not perfectly suitable to deal with the challenges of current time a economy is facing. Thus we can say that the most prominent merit of floating exchange rate is that it allows the nation to pursue internal econimic goals freely on the other hand fixed exchange rate system  promote international trade and investment specially in case of a  developing country. In this way floathing exchange rate is a better option than fixed exchange only if the nation is economically independent.