Basically foreign exchange is of two types, fixed and flexible exchange rate. So friends, in today’s article we are going to know about Fixed and Flexible Exchange Rate (Difference between Fixed and Flexible Exchange rate). So let’s discuss in details.
Table of Contents
What is Fixed Exchange rate?
Fixed Exchange rate definition – Under fixed exchange rate system the monetary authority or the government fixes the rate of exchange which is assumed to be constant. Fixed exchange rate example – Gold standard system of exchange rate.
Merits of Fixed Exchange rate
The merits of fixed exchange rates are mentioned below –
• Fixed exchange rate helps in coordinating various economic policies among different countries of the world.
• Fixed exchange rate means low risk. So, it encourages international trade.
• It ensures stability in the international exchange market.
• It helps to device long term economic policies.
Demerits of Fixed exchange rate
The demerits of fixed exchange rate are mentioned below –
• It is rigid exchange rate system. Hence, it disturbs international allocation of resources.
• This system is suitable when a country occupies a huge reserve of gold, but it is a rate phenomenon.
• This rate of exchange does not encourage foreign capital or foreign investment.
• It requires unnecessary interventions. It disturbs for international payment system.
• It is supported with big international resources of gold but in reality it is very difficult.
What is Flexible Exchange rate?
Flexible Exchange rate meaning – Flexible rate of exchange or Flexible Exchange rate is that rate which is determined by the demand for and supply of foreign exchange in the exchange market.
It is determined by the free market forces of demand and supply. It means that equilibrium rate of exchange is influenced by the market forces.
Merits of Flexible Exchange rate
Following are the merits of flexible exchange rate –
• Flexible exchange rate promotes foreign capital movement across the world.
• Flexible exchange rate is influenced by the profit motive. Hence, it ensures optimum use of the international trade and resources.
• It is a superior exchange rate system which does not require any international resources.
• It is not be supported with international reserve of gold.
• This system promotes venture capital in the foreign exchange market.
Demerits of Flexible exchange rate
Following are the demerits of flexible exchange rate –
• Instability is the greatest disadvantage of this system.
• This system creates uncertainty in the international capital market.
• This system disturbs the macro economic variables in the domestic market such as employment, income, investment and saving, etc.
• This exchange rate is not suitable for rapid economic development. This is because change in the flexible exchange rate disturbs the other economic activity.
Difference between Fixed and Flexible Exchange rate
The difference between fixed and flexible exchange rate (Fixed VS flexible exchange rate) can be written as follows –
|Fixed Exchange Rate
|Flexible Exchange Rate
|(i) Fixed exchange rate remains constant and it is an unrealistic rate of exchange.
|(i) One the other hand, flexible exchange rate is a realistic rate which is determined by the free market forces.
|(ii) Fixed exchange rate minimizes risk.
|(ii) Flexible exchange rate maximizes risk.
|(iii) The fixed exchange rate does not encourage free flow of foreign capital.
|(iii) Flexible exchange rate promotes free flow of foreign capital world wide.
|(iv) The fixed exchange rate is maintained by the monetary authority of the country.
|(iv) But the authority can not influences the flexible exchange rate.
|(v) The fixed exchange rate requires huge reserve of foreign exchange or gold.
|(v) But flexible exchange rate does not required any reserved.
So friends, this was the concept of Fixed and Flexible Exchange Rate (Difference between Fixed and Flexible Exchange rates). Hope you get the full details about it and hope you like this article.
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