Question

1. Explain the difference between fixed rate exchange system vs. the floating exchange rate system. Explain the advantages and disadvantages for each system.  image answer is not allow

Answer 1

Differences between fixed exchange rate and floating exchange rate

1. Fixed Exchange rates are rates set by the central government to be maintained at constant level where as floating rates are determined by the market forces of demand and supply.
2. In fixed exchange rate the devaluation and revaluation is done by Government in specific periods whereas in floating rates the appreciation and depreciation happen in real time .
3. In fixed exchange rate the government maintains constant rate by increasing or decreasing money supply by rate cuts or hike in rate where in floating rates move in the direct to balance market forces .

Advantages of Fixed Exchange rate
1. The importers and exporters are assured for exchange rate and can plan according as they are protected for exchange rate fluctuations.
2. Foreign Investors can invest without thought of foreign exchange risk.
3. Other countries with floating exchange rate might frame polices with countries with fixed interest rate t0 make there domestic companies more competitive.

Disadvantages of fixed Exchange Rate :
1. Speculation can be high when the market senses that the government might take steps to balance the market forces by increasing or decreasing rates.
2. It reduces flexibility in the economy
3. There might be a current account deficit because of this.


Advantages of floating exchange rate :
1. No need of government intervention as the market forces stabilizes the exchange rates.
2. It is Market friendly as it encourages investors and foreign trade.
3. It helps in counterbalancing inflation. When inflation is low exchange rate is high and when inflation is high exchange rates become low.

Disadvantages of floating exchange rates:
1.Due to uncertainty FDI ( Foreign Direct investment ) might be low as these investments are for longer term .
2. Day to day speculations can occur and fluctuations do cause arbitrage opportunity.
3. It might influence government to push for expansionary monetary policy which might disturb the economy as they are not under pressure to manage exchange rate.

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