What are the Merits and Demerits of Flexible and Fixed Exchange Rate Systems?

Merits and Demerits of Fixed Exchange Rate System

The main aspect of a fixed exchange rate system is that there must be a reliability that the government will be able to perpetuate and maintain the exchange rate at the mentioned degree of level. Often, if there is a deficit in the balance of payment in a fixed exchange rate system, governments have to take care of the gap by the use of their official reserves.

If people are aware that the amount of reserves are insufficient, then they begin to be sceptical about the capability of the government to maintain the fixed rates.

This may increase the hypothesis of devaluation. When this reliance translates into aggressive purchasing of one currency, thereby forcing the government to devalue, it is known to compose a notional attack on the currency.

Fixed exchange rates are liable to such types of attacks as observed in the time period before the subside of the Bretton Woods system.

Merits and Demerits of Flexible Exchange Rate System

A flexible exchange rate system provides the government with more flexibility, and it does not need to perpetuate large stocks of foreign exchange reserves. The vital merit of flexible exchange rates is that movements in the exchange rate instinctively takes 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 with maintaining the exchange rate, which is instinctively taken care of by the market.

This article is about the merits and demerits of flexible and fixed exchange rate systems for class 12 students. To know more, stay tuned to our website.