In case of a floating exchange rate, the central bank does not have to take so many efforts. It can adversely affect a country that has high unemployment. Advantages Market Determined Rates: On the other hand, when market forces determine the rate, it is called floating exchange rate.
If you believe a central bank should inflate your currency to stimulate your economy, or to discourage imports, you lose that ability.
Advantages and disadvantages of floating exchange rates Advantages of floating exchange rates Protection from external shocks - if the exchange rate is free to float, then it can change in response to external shocks like oil price rises.
This will help restore the competitiveness of exports. Problems with reserves - fixed exchange rate systems require large foreign exchange reserves and there can be international liquidity problems as a result.
The uncertainty introduced by floating exchange rates may discourage direct foreign investment i. In the short run, traders find it difficult to engage in foreign trade since they are not aware of the exact prices that their goods will fetch them.
The floating rate system is simply a lot more convenient since it does not have any such requirements. The value of currencies change on a real time basis. Countries may become involved in rounds of competitive devaluations in order to capture a competitive advantage.
Rather the appropriate choice depends on how the country views the Forex markets and what its long term objectives are.
A country is more insulated from the inflation of other countries. This is because the Central Bank does not have to conduct active trading operations in order to maintain the value of the currency. In between these two extreme rates, there are some hybrid systems like Crawling Peg, Managed Floating.
It may make each country and its MNCs more vulnerable to economic conditions in other countries. It resembles the freely floating system in that exchange rates are allowed to fluctuate on a daily basis and there are no official boundaries.
Also, since Forex market is not regulated, currency values could skyrocket or hit rock bottom in a matter of minutes. Lack of policy constraints - the government are free with a floating exchange rate system to pursue the policies they feel are appropriate for the domestic economy without worrying about them conflicting with their external policy.
This will help restore the competitiveness of exports. Managed Float Exchange Rate System — The exchange rate system that exists today for most currencies lies somewhere between fixed and freely floating.
How these could have been dealt with under a system of fixed exchange rate is not yet clear. Whereas a fixed exchange rate system allows no flexibility for exchange rate movements, a freely floating exchange rate system allows complete flexibility. Under this system, the central bank, without intervention, allows the exchange rate to adjust so as to equate the supply and demand for foreign currency In India, it is flexible exchange rate which is being determined.
The system of exchange rate in which rate of exchange is determined by forces of demand and supply of foreign exchange market is called Flexible Exchange Rate System. This may give the system a deflationary bias. It may make each country and its MNCs more vulnerable to economic conditions in other countries.
The ability to sort information is an advantage of a knowledgemanagement system. The value of currencies change on a real time basis. In a situation of excess demand, central bank uses its reserves to maintain foreign exchange rate.
Disadvantages of fixed exchange rates The economy may be unable to respond to shocks - a fixed exchange rate means that there may be no mechanism for the government to respond rapidly to balance of payments crises. A freely floating exchange system does not require the central bank to hold massive reserves.
Finally, floating exchange rates should mean that three is hardly any need to maintain large reserves to develop the economy. It is similar to the fixed rate system in that governments can and sometimes do intervene to prevent their currencies from moving too far in a certain direction.
Disadvantages of Fixed Exchange Rate System — 1. Low Requirement of Reserves: Some of the important ones have been listed below: This will also cause instability and uncertainty for firms and consumers. Hence, the countries that have their currencies pegged to the dollar have limited independence whereas countries that let their currencies float have a far greater degree of independence.
On the country if a fixed exchange rate policy is adopted, then reducing a deficit could involve a general deflationary policy for the whole economy, resulting in unpleasant consequences such as unemployment and idle capacity.
A managed float is halfway between a fixed exchange rate and a flexible one as a country can obtain the benefits of a free floating system but still has the option to intervene and minimize the risks associated with a free floating currency.
For example, if a currency’s value increases or decreases too rapidly, the central bank may decide to.
Advantages and disadvantages of fixed exchange rates Advantages of fixed exchange rates Certainty - with a fixed exchange rate, firms will always know the exchange rate and this makes trade and investment less risky. Advantages and Disadvantages of Freely Floating Exchange Rates The freely floating currency system is the predominant system of foreign exchange that is prevalent in the world today.
As globalization has progressed, more countries have abandoned their currency pegs and have allowed their currencies to freely float.
The fixed exchange rate dynamic not only adds to a company's earnings outlook, it also supports a rising standard of living and overall economic growth.
A free-floating currency where the external value of a currency depends wholly on market forces of supply and demand Fixed and floating exchange rates - revision video The Euro floats against the US dollar in foreign exchange markets The main arguments for adopting a floating exchange rate system.
Whereas a fixed exchange rate system allows no flexibility for exchange rate movements, a freely floating exchange rate system allows complete flexibility. A freely floating exchange rate adjusts on a continual basis in response to demand and supply conditions that currency.
Advantages of Freely Floating Exchange Rate System – 1.Advantages of managed floating exchange rate system