ECO610 Discussion 2 Week 5 Exchange Rate Systems

Now, your task is to explain whether a fixed or floating exchange rate system would cause more significant gains from international asset trade. In your answer, please focus on the change in policy concerning monetary policy and its influence on exchange rates.

A currency exchange rate can either be a floating one or a fixed one. On the other hand, a fixed exchange rate is mainly determined by the central bank of a particular country. In contrast, market demand and supply dynamics determine a floating exchange rate. In addition, fixed rates provide certainty for exporters and importers, given that it enables the government to maintain a lower inflation rate which maintains interest rates low. When interest rates are kept low, trade and investments are stimulated to benefit from international asset trade. Generally, a fixed exchange rate system promotes international trade and investment, one of the vital factors for growth, especially for developing nations.

On the other hand, a floating exchange rate is better for nations with a stable and effective monetary policy. Currencies with a floating exchange rate have the potential to trade without restrictions as compared to a case of a national operation with a fixed exchange rate. Compared to a fixed exchange rate, floating exchange rates have little to no influence on central banks and the government. However, in unique instances where the particular nation requires that the price remains favorable in global trade, the government and the central bank may help maintain the prices for the country in international trade (Corporate Finance Institute, 2022). Unlike a fixed exchange rate, a floating exchange rate excludes fiscal authorities and monetary authorities free to pursue internal goals. Some of the internal goals include stable growth, employment, and price stability.

Reference

Corporate Finance Institute. (2022, January 29). Floating exchange rate. https://corporatefinanceinstitute.com/resources/knowledge/economics/floating-exchange-rate/ ]