Fixed vs. Floating exchange rates - Essay Example

Fixed vs. Floating exchange rates In a nutshell, an exchange rate refers to the price in one nation’s currency of one unit of another nation’s currency. Ever since the collapse of the Bretton Woods regime (soft peg) in the 1970’s, economists have never concluded the debate whether fixed or floating exchange rates are preferable. In my opinion, foreign exchange rates are crucial promoting international transactions while ensuring adjustments to disequilibrium and shocks. In effect, there are 2 systems of exchange rates i.e. fixed exchange rate regime as well as floating exchange rate regime.

In fact, a country can only adopt only one of the two foreign exchange rate regimes. What is more, there are two types of fixed exchange rate regimes i.e. hard peg and Soft peg regimes. In addition, there are also two types floating rate regimes i.e. dirty float and clean float regimes. Over the years, fixed exchange rates have promoted international trade. Moreover, the key benefit of fixed exchange rate regime to a country’s economy is assurance; as people in different countries are aware the everyday value of their country’s currency.

Besides, fixed exchange rates also compel monetary control by preventing governments from inflationary monetary practices such as printing more money. On the contrary, floating exchange rates raise exchange rate uncertainty, therefore, hampering international trade. Moreover, floating exchange rates contribute to inflationary anxieties; due to lack of the benefits of the fixed exchange rate regime, which impedes domestic policies which eat into net exports of a country. Consequently, inflation is ultimately a result of macroeconomic policies implemented by national governments as well as their central banks.

Through floating exchange rates, folks are less likely to take part in international trade because of uncertainty of how many. Certainty is an essential part of international trade; floating exchange rates hamper international trade. Additionally, proponents of floating exchange rates, uphold that it’s better for a nation to assume policies that rally its domestic economic goals than to forego domestic economic goals to keep an exchange rate. Furthermore, there’s a great possibility of fixed exchange rate diverging notably from the equilibrium exchange rate; hence generating a constant balance of trade predicaments.

Consequently, deficit nations usually enforce trade restrictions (quotas or tariffs) which hinder international trade as a counter measure.During the 2008 global financial crisis, the currencies of various nations globally experienced huge declines. The crisis highlighted how the choice of a foreign exchange rate system impacts a country’s economy. During the crisis, financial flows as well as collapsing trade caused large balance of payment gaps, causing high exchange rate instability, as well as rapid depreciation.

The exchange rate losses also differed considerably. Before the crisis, most of the currencies that declined had enjoyed immense economic gains caused by strong macroeconomic performance and favorable global economic and financial conditions. In addition, waning interest rates in developed countries led to materialization of large carry trade operations to many African countries, which thanks to their steady exchange rates as well as microeconomic situation drew significant direct investment.

In light of these, economists continue to grapple with the question whether fixed of floating exchange rates are preferable?