Question

How does flexible exchange rate system enhance efficiency in resourse allocation?

Answer 1

Dear Aarti,
Under flexible exchange rate system, the rate of exchange is determined by the market forces (demand and supply of foreign exchange) with less or no government intervention. As the Exchange rate is determined where the demand of foreign exchange meets up the supply of foreign exchange therefore it started to play a fundamental role in the allocation of foreign exchange resources, adjust the relation between domestic and foreign prices in a flexible manner, channel resources to the sectors that are driven by domestic demand such as the services sector, promote industrial upgrading, transform the pattern of economic development, reduce trade imbalances and over-reliance on export, enable domestic demand to play a more important role in economic development and thus promote efficiency in resource allocation.