Question

) What are fixed and floating exchange rate regimes? Discuss the effect of adopting a fixed exchange rate regime on emerging market economies. [10 marks]

Answer 1

Fixed and floating exchange rate regime are two different kind of exchange rate regimes in which exchange rates are either fixed or not fixed.

In fixed exchange rate regime, exchange rate of domestic country is fixed with the exchange rate of the foreign country and this is also known as the pegging of the exchange rates because this will be leading to regular intervention by the government in order to stabilize the currency and it will mean lesser flexible and transparent market.

Floating rate regime is a exchange rate regime in which domestic currency is not pegged against the foreign currency and it is decided by the twin factors of demand and supply to discover the actual prices of one currency against the another,and it is followed over the globe in recent times because it is an age of modernization and globalisation and there is intervention in this regime also but these interventions by government are not like those fixed currency regimes.

Adaptation of a fixed exchange rate regime will mean that emerging markets will be lesser reactant to the Global events and event related risk but there would also be a lesser flexibility and transparency, and it will lead to lesser foreign direct investment because global investors are also sceptical of the Government interventions of management of the exchange rate and it will hamper the overall growth of the economy as there is no fair priceprice discovery mechanism.