Question

What are the main arguments surrounding the fixed vs. floating exchange rate systems? Which one is most suitable for today's global economy? Defend your answer.

Answer 1

Fixed and floating exchange rate systems are two ways to manage the exchange rate system for any economy. There are arguments in support of the fixed exchange rate system. The first argument is the certainty and stability in the exchange rate that promotes international trade. The second argument is the long term investment in the economy as rates are already known and planning takes place. The third argument is the lower inflation rate in the economy due to stability in prices due to fixed exchange rate system.

There are arguments in favor of a floating exchange rate system as well. The first argument is the exchange rate acts as an automatic stabilizer for the economy. For example, a decrease in exchange rate, increases the exports that reduce the trade deficit and it again stabilize the exchange rate. The second argument is the monetary policy autonomy that is necessary for the long term growth of the economy. The third argument is the symmetry brought in by the floating exchange rate system to the economy and it provides equal opportunity for all the nations to influence the exchange rate with its macroeconomic policy and economic growth.

In the context of the global economy, the floating exchange rate system is more suitable, because it first frees the central bank to implement its monetary policy that is best for the economic growth, stability and development. It is important in the long run to control the inflation in the economy as well. Further, exchange rate becomes stabilized against each other and trade is facilitated in international market. So, floating exchange rate also works as an automatic stabilizer in the economy. Besides, in the global economy, nations want true exchange rate value of the their domestic currency and it is only provided by the floating exchange rate system.