Fixed and Floating Exchange Rate

What is an exchange rate?

It is a rate at which one currency is traded with another. Or in simple words, it is the value of one currency with respect to another currency.  For example, if 1 pound is equal to 2 dollars, this means that you have to pay 2 pounds to purchase bus ticket of 4 dollars in the USA.

What is fixed exchange rate?

Fixed exchange rate or pegged exchange rate is a kind of currency exchange system in which value of one currency is fixed against major world currency like the dollar, euro and pound etc. or with another measure of significance worth like gold etc. The central bank usually plays an active part to maintain official currency rate by buying and selling home currency in the international market in return for currency to which it is pegged.

What is floating exchange rate?

Floating or flexible exchange rate is determined by supply and demand forces in the private market. If the value of the currency is high its demand will increase and vice versa. The central bank may intervene to control inflation and stability.

Difference between Fixed and Floating Exchange Rate

Fixed Exchange Rate Floating Exchange Rate
Meaning It refers to rate sets and maintains by the central bank (Government). It is the rate which changes with respect to changes in the market.
Controlled by Central government or central bank. Demand and supply forces of the market.
Changes When currency price increases, it is called revaluation and when price decreases, it is called devaluation. When currency price increases, it is called appreciation and when price decreases, it is called depreciation.
Speculation It might occur when there are chances of changes in policies of the government. It is an integral part of this system and occurs normally.
Government intervention Government intervenes at the time of high inflation to stable the currency. No interference of government.

Conclusion

It is not possible to make a particular conclusion; both fixed and floating exchange rate have their positive and negative sides. Many economists consider flexible rate system because of its dependence on the free market. However, Lawmakers, central bank officials support fixed exchange rate system.

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