Question

7.Name two advantages to a floating rate exchange regime.

8.Name two disadvantages to a floating rate exchange regime.

9.Name two advantages to a fixed rate exchange regime.

10.Name two disadvantages to a fixed rate exchange regime.

Answer 1

The advantages of a fixed exchange rate include:

• Providing greater certainty for importers and exporters, therefore encouraging more international trade and investment.
• Helping the government maintain low inflation, which can have positive long-term effects such as keeping down interest rates.

However, there are also several disadvantages of fixed exchange rates, particularly for larger and more developed economies.

The disadvantages of a fixed exchange rate include:

• Preventing adjustments for currencies that become under or overvalued.
• Limiting the extent to which central banks can adjust interest rates for economic growth.
• Requiring a large pool of reserves to support the currency if it comes under pressure.

ADVANTAGES OF FLEXIBLE EXCHANGE RATE

1. ELIMINATE THE NEED OF CENTRAL BANK TO HOLD THE RESERVES.

2. FACILITATE DOMESTIC ECONOMIC AUTONOMY BY REMOVING EXTERNAL CONSTRAINT ON BALANCE OF PAYMENT EQUILIBRIUM

DISADVANTAGES

1.ABSENCE OF BALANCE OF PAYMENT CONSTRAINT MIGHT FOSTER THE PURSUIT OF DOMESTIC ECONOMIC POLICIES TO LONG RUN MAXIMIZATION

2.DESTABILIZING SPECULATION MAY INCREASE VOLATILITY BY PUSHING EXCHANGE RATE FARTHER