This can be prevented by the stable exchange rate. If a country is already experiencing economic troubles like high inflation rates, currency depreciation may likely cause the inflation rate to soar even higher because the demand for its goods has risen. Thus, the possibility of international monetary crisis originating from exchange rate changes is automatically eliminated. Indeed, in some of these countries, commentators have argued in favour of the outright adoption of the U. For instance, a deficit in the balance of payments would trigger currency depreciation. Brought to you by No Exchange Rate Risk A fixed exchange rate removes the risk of exchange rate changes.
It is not possible for economists to reach a particular conclusion, so the debate is indecisive, as counter arguments keep coming from both regimes. Another advantage is that reserves are not used to control the value of the currency. Countries with free-floating exchange rates do not have that problem. When supply and demand moves freely, the domestic economy is protected from fluctuations in the world economy. The Australian dollar appreciates against the dollar as a result. Furthermore, fixed exchange rates ensure sensible government policies on inflation as inflation has a very harmful effect on the demand for exports and imports.
If membership of a fixed exchange rate is short-lived in defeats the purpose and rather than gradual changes in the exchange rate, there is added uncertainty and speculation about the exchange rate. Moreover, as part of a major restructuring effort by the private sector, businesses have been investing heavily in machinery, equipment, and technology. But the fallouts of these measures are rising prices and rising unemployment. In floating exchange rate systems, central banks buy or sell their local currencies to adjust the exchange rate. Extreme short-term moves can result in intervention by central banks, even in a floating rate environment. That discussion has revolved around such questions as: Should we continue floating, or should we peg our currency to the U. The cost to your subsidiary of making the interest payments to the U.
Conversely, in the case of fixed exchange rate speculation takes place when there is a rumour about change in government policy. Indeed, over the past couple of years, it has been a topic of considerable public discussion. Firstly, it requires the country to maintain a huge currency reserve. The volume of the sales should decline as the cost to consumers who finance their purchases would rise due to the higher interest rates. For example, high inflation countries will be uncompetitive versus low inflation countries. Presumably, we would also be able to keep some of the revenue or seigniorage from issuing that common currency. These then reduce economic growth.
You will walk away with the premium you had collected at the time of the option's sale. This is due to the increase in imports and decrease in exports often associated with a strong home currency imports become cheaper to that country but the country's exports become more expensive to foreign customers. There is still risk that the govt. This will place an upward pressure on the foreign currency. Furthermore, domestic companies might experience greater employment as the low exchange might encourage consumers to spend more on domestic goods and services, rather than importing goods and services.
By contrast, a floating exchange rate liberates domestic policies and automatically devalues the currency to correct the external imbalance. The uncertainty of exchange rate fluctuations can reduce the incentive for firms to invest in export capacity. . Those reserves, therefore, can be used to import capital goods to promote economic growth. However, it also can cause higher inflation since there is a reduction in foreign competition.
Disadvantages of a fixed exchange rate are that the government is compelled to keep the exchange rate fixed. The first one relates to the incentives for business to innovate and invest in new technology. On the other hand, a fixed or pegged rate is determined by the government through its. These reserves have an opportunity cost. Fixed exchange rate systems were common during the first half of the 20th century. Concluding thoughts Let me summarize my main points. However, it was used when major economies took part in it.
Therefore, the advantages of fixed rate system are the disadvantages of the floating rate system and vice versa. Another example involves the fiscal restraint measures that were undertaken by our federal and provincial governments, beginning in the mid-1990s, to deal with persistent deficits and the resulting unsustainable accumulation of public debt. This is because imports will be greater than exports meaning the supply of sterling on the foreign exchanges will be increasing as importers sell pounds to pay for the imports. An exchange rate is the price of one currency expressed in terms of another. To help the transfer of resources from the public to the private sector and so support overall demand in Canada, we needed lower interest rates here than in the United States. In a fixed exchange rate, it is difficult to respond to temporary shocks. Furthermore, high level of reserves need to be maintained to make it clear that it is able to defend its currency by the buying and selling of foreign currencies.
This requires large amounts of reserves, as the country's government or is constantly buying or selling the domestic currency. This would result in depreciating dollar. Fiscal policy tends to be weaker. A country with stable exchange rate can attract more funds as. But like I said even fixed exchange rate is not fully fixed.
Under a managed float system, governments will allow exchange rates to move according to market forces; however, they will intervene when they believe it is necessary. Therefore, the exchange rate is not under the control of the government or central bank. Interest rates are free to be employed as domestic monetary tools. Investment and trade may be adversely affected. Moreover, a fixed exchange rate does not eliminate currency risk. Manipulating supply and demand will only weaken the market.