Question

Explain how exchange rates are determined under the fixed exchange rate system. Then, thoroughly discuss the advantages and disadvantages of the fixed exchange rate system.

Answer 1

Answer :-

In a fixed exchange rate system, exchange rates are fixed by the central bank of each country and are not permitted to change in response to changes in currency demand and supply.

Maintaining the constant value of a currency at its fixed rate requires constant intervention by the central bank or government of each country.

This intervention takes the form of buying and selling currencies by the central bank, as well as making other adjustment in the domestic economy to create equilibrium in an economy.

Advantage:

1. Reduces uncertainty enabling economic planning.

2. Governments will keep inflation low to keep businesses internationally competitive

Disadvantages :-

.1. Government may have to raise cash rates to control inflation.

2. Government will need to keep high levels of forex to defend its currency.

3. Finding the right level difficult to ensure exporters are competitive.

4. Artificially low fixed rates may be seen as an unfair trade advantage and lead to economic dispute