Merits and Demerits of Flexible and Fixed Exchange Rate Systems

What are the merits and demerits of fixed exchange rate system?

The main aspect of the fixed exchange rate system is that, there must be reliability that the government will be able to perpetuate and maintain the exchange rate at the degree of level mentioned. Often, if there is a deficit in the Balance of Payment, in a fixed exchange rate system, governments will have to interfere to take care of the gap by the use of its official reserves. If people are aware that the amount of reserves is insufficient, they would begin to be skeptical about the capability of the government to maintain the fixed rate. This may increase the hypothesis of devaluation. When this reliance interprets into aggressive purchasing of one currency hereby forcing the government to devalue, it is known to compose a notional attack on a currency. Fixed exchange rates are liable to such types of attacks, as has been observed in the time period before the subside of the Bretton Woods System.

What are the merits and demerits of flexible exchange rate system?

The flexible exchange rate system provides the government more flexibility and they don’t need to perpetuate large stocks of foreign exchange reserves. The vital merit of flexible exchange rates is that movements in the exchange rate instinctively take care of the deficits and surpluses in the Balance of Payment. Also, nations gain independence in regulating their monetary policies, since they do not have to interfere to maintain exchange rate which are instinctively taken care of by the market.

The above mentioned is the concept that is explained in detail about Merits and Demerits of Flexible and Fixed Exchange Rate Systems for the class 12 students. To know more, stay tuned to BYJU’S.

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