Advantages/Disadvantages of a Fixed Exchange Rate
To achieve economic stability, the right exchange rate should be chosen according to the financial circumstances of a country. The exchange rate in simple words is the value of one currency compared to the value of another fixed currency when someone buys it. A country with a small economy should adopt the gold standard to regulate transactions in the flourishing international trading market. Malaysia, Thailand, and Indonesia used fixed exchange rates before 1997. After 1997 these countries implied floating exchange rates.
“A pegged exchange/ fixed exchange rate” can be understood as a currency value is standard and fixed while converting it to another currency. The most prominent benefit of a fixed exchange rate is that it evades currency fluctuations by making their currency predictable and consistent. The fixed rate of the currency facilitates in the reduction of the risk of a country’s foreign investment/ income and deflates “economic inflation”. The biggest drawback of the fixed exchange rate is that if the market value goes down in the international market, the countries using floating exchange rate will get the monetary benefits from trade transactions, however, the countries using fixed exchange rate will not achieve this benefit (this situation is vice versa for the countries with fixed exchange rate if the international market value goes up).
In opposite, the flexible exchange rate always change conferring to “supply and demand”. This implies if the demand of the currency is less or it is easily accessible, its value goes down, and on the other hand, if it is in demand, the value goes up with the conversion scale. The floating exchange rate is impacted by the private market with the variation of “supply and demand”. The floating exchange rate facilitates decreasing vulnerability and increased investment. This type of exchange rate provides automatic stabilization in the discrepancy in the balance of payments. Inflation can be controlled by it. Furthermore, this exchange rate provides crucial free cash flow and flexibility for cash flows. At the same time, it brings fluctuation and uncertainty to the country’s economy and investments.
Bandyopadhyay and Bandyopadhyay—2008—Monetary Policy by Indonesia, Malaysia and Thailan.pdf. (n.d.). Retrieved February 23, 2021, from https://www.econ-jobs.com/research/51847-Monetary-Policy-by-Indonesia-Malaysia-and-Thailand-in-the-Era-of-Excess-Forex-Reserves.pdf
Economic Issues No. 13—Fixed or Flexible?—Getting the Exchange Rate Right in the 1990s. (n.d.). Retrieved February 23, 2021, from https://www.imf.org/external/pubs/ft/issues13/
fixed vs floating exchange rate explained—Clear Currency. (n.d.). Retrieved February 23, 2021, from https://clearcurrency.co.uk/stories/whats-the-difference-between-fixed-and-floating-exchange-rates
Frankel, J. A. —2003— Experience of and lessons from exchange rate regime in emerging economies (No. w10032). National Bureau of Economic Research.