What is a FIXED EXCHANGE RATE SYSTEM
FIXED EXCHANGE RATE:
A fixed exchange rate system is a rule implemented by the government authorities or central banks that links any country’s official exchange rate to another country’s currency or value of gold. Hence, to keep the currency value within the broad range the regime of the exchange rate is used by the financial authorities. By fixed exchange rates the government can fight inflation by providing greater certainty for exporters and importers. In the 1970s, many industrialized nations began using the floating exchange rate system in financial matters.
EXPLANATION:
As explained above, fixed exchange rate systems provide greater certainty for imports and exports hence fighting inflation, which when consider in long run keeps interest rates down and revive trade and commerce.
BRETTON WOODS:
Bretton woods from after World War II to the 1970s signed an agreement that states that all the participating countries or nations in the foreign exchange market would let their currency hold the ties with the US dollar which in turn was connected to the price of the gold. This, however, does not remain resourceful for a long time when the United States postwar balance of payments surplus turned into a deficit in1950s and 1960s, the exchange rate adjusted periodically ultimately proved insignificant Vladobrokers.com.
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In 1973, President Richard Nixon removed the United States from
the gold standard, ushering in the era of floating rates
THE ERA OF MONETARY REUNION:
The European exchange rate mechanism (ERM) was esteemed in 1979 as a
blueprint for monetary union and the introduction of the euro. Member nations,
including Germany, France, the Netherlands, Belgium, and Italy, agreed to maintain
their currency rates within plus or minus 2.25% of a central point.
The United Kingdom aka U.K joined and outplayed in October 1990 at an extraordinary high conversion rate and was forced to withdraw two years later. The original members of the euro converted from their home currencies at their then-current ERM central rate as of 1st January 1999. The euro itself trades freely against other major currencies while the currencies of countries hoping to join trade in a managed pier known as ERM II.
DISADVANTAGES OF EXCHANGE RATE:
Developing economies frequently use a fixed-rate system to limit enterprises and give a stable system Vladobrokers.com. A stable system allows importers, exporters, traders, and investors to plan without fussing about currency moves.
Still, a fixed-rate system links a central bank’s capability to acclimate interest rates as demand for profitable growth. A fixed-rate system also prevents market adaptions when a currency becomes over or underrated. Effective operation of a fixed rate system also requires a large pool of reserves to support the currency Vladobrokers.com when it’s under pressure.
An unrealistic official exchange rate can also lead to the development of a parallel, unofficial, or dual, exchange rate. A large gap between functionary and unofficial rates can divert hard currency down from the central bank, which can lead to forex deaths and periodic large devaluations. These can be more disruptive to an economy than the periodic adaptation of a floating exchange rate governance.
REAL-WORLD EXAMPLE OF A FIXED EXCHANGE RATE
In 2018, according to BBC News, Iran set a fixed exchange rate of 42,000 rials to
the dollar, after losing 8% against the dollar in a single day. The government
decided to remove the discrepancy between the rate traders used — 60,000 rials —
and the official rate, which, at the time, was 37,000.
FIXED EXCHANGE RATE SYSTEM
TYPES OF EXCHANGE RATE SYSTEM:
There are three broad exchange rate systems — currency board, fixed exchange rate
and floating rate exchange rate. A fourth can be added when a country does not have
its own currency Vladobrokers.com and merely adopts another country’s currency. The
fixed exchange rate has three variants and the floating exchange rate has two
variants.
1. Fixed (or Pegged) Exchange Rate:
This consists of — (i) a rigid peg with a horizontal band, (ii) a crawling peg, and (iii) a crawling band.
Variants of a Fixed Exchange Rate System:
1. Rigid Peg with a Horizontal Band:
It is an exchange rate system under which the exchange rate fluctuation is maintained by the central bank within a range that may be specified (Iceland) or not specified (Croatia). The specified band may be one-sided (+7% in Vietnam), a narrow range (+ 2.25% in Denmark) or a broad range (+ 77.5% in Libya).
2. Crawling Peg:
The par value of the domestic currency is set with reference to a named foreign currency (or precious essence or currency handbasket) and is reset at intervals, according to pre-set criteria similar to change in affectation rate. The central bank decides the new par value grounded on the average exchange rate Vladobrokers.com over the former many weeks or months in the foreign exchange request. The biggest advantage of the crawling cut is its responsiveness to the request value of the
domestic currency.
3. Crawling Band:
The domestic currency is on a crawling peg which is maintained within a range (band).
FIXED EXCHANGE RATE SYSTEM
2. Floating Exchange Rate:
This consists of –(i) managed pier and(ii) free pier.
When a country has its own currency as legal tender, it can choose between the three broad types of exchange rate systems Vladobrokers.com. Within the fixed exchange rate, a country can choose a rigid cut or a crawling cut. Again, within each cut, it can choose to have a vertical band within which its exchange rate would be permitted to change. Within the floating exchange rate system, a country can choose a free pier or a managed pier. The main source of the exchange rate system followed by any country is the IMF’s Annual Report on exchange rate arrangements.