Question

What are the advantages of fixing or floating and exchange rate? What is the “unholy trinity” of the Mundell-Fleming theory and how does it relate to the choice of exchange rate regime? How does the Mundell-Fleming theory relate to the contemporary era of the world economy and the Euro in particular?

Answer 1

Advantages of fixed exchange rate system -

1) Under fixed exchange rate system, the values of currency against one another does not flactutae to change in market forces which makes the certainty as the biggest advantage of it. The values of the rates are always certain as they dont falctuate with market forces aand hence help the investors and traders to face no risk in exchnaging currencies.

2) With no chance of being affected by changes in market forces the speculation also does not exist. Soeculation also affects further the exchnage rate system when system is of flactuating tyoe which increases the risk.

3) Irresponsible policies of macro level will not be pursued by the government as there will be constraint on govt regulation policies becaus eof fixed rates.

Advanatges of floating exchange rate system -

1) Under floating exchnage rate system the exchange rates between currencies automatically changes because of change in market forces. It hence does not require international managemnet of exchnage system.

2) being managed by its own it also doesnot require frequent intervention by central banks.

3) The system automatically adjusts to external shocks like rise in oil prices.

4) It also corrects balance of payment deficit as it can automatically makes a currency depreciate to which new investment can be bagged to rdeuce the deficit.