It can also be so because exchange rates sometimes overshoot their long-run values. The market corrects the rate automatically reflecting inflation and other market conditions influencing the economy.
In this system, a currency links its value to another but gives it fluctuation limits and is immensely valuable if a currency linking itself has expectations of being volatile exceptionally, hence allowing itself to fluctuate to a level acceptable under the conditions. In this system, the authorities determine the value around which the currency can fluctuate.
Fixed exchange rate system
Here, a currency has a direct convertibility towards another currency with the government trying to keep the value constant against the other currency. The government decrees the worth of its currency against the value of another, plus rules of the exchange.
b) Advantages and disadvantages of Floating rate exchange system
Flexibility, which enhances the capability of the country market economy to pick up and adjust quickly to the changing market conditions, is the main advantage of this system.
In case of a violation of the balance of payments deficit, this system of exchange allows for adjustment of outflow and/or inflow making either domestic or foreign goods more competitive depending on whether there was appreciation or depreciation in the currency market.
Another advantage is the automatic determination of interest rates within the country, allowing efficient control of the economic balance. ...Show more