Question

URGENT!

Why is fixed exchange rate system preferable when there is a pressure of depreciation to the local currency and the need of expansionary monetary policy to fight recession?

Answer 1

Fixed Exchange rate systems helps to peg the exchange rate even when the exchange rate would have depreciated or appreciated had there been floating rate. Fixed ER(Exchange Rate) plays a crucial role when faced with pressure of depreciation of local currency and hence need for monetary exapansion.

This is because, as we know, an increase in the money supply will lead to lower interest rate and thuss raise investment which would stimulate the economy and help come out of the recession. However, lowering interest rate means that the foreign individuals now have less incentive to invest here because they will get lower return. Then they will try to take capital )i.e. funds) out of the country. This would however, lead to depreciated exchange rate. To prevent such depreciation, the fixed exchange rate system is adopted. Because if it depreciates then it will be costlier to import goods and services which would further worsen the recession.