Under the floating system if a country has large current account deficits its currency depreciates. Unlike fixed exchange rates based on a metallic standard floating exchange rates don t require an international manager such as the international monetary fund to look over current account imbalances.

Explaining The Difference Between Fixed And Floating Exchange

Floating exchange rates have these main advantages.

Advantages and disadvantages of fixed and floating exchange rates. No need for international management of exchange rates. A fixed exchange rate occurs when a country keeps the value of its currency at a certain level against another currency. Since all these conditions are absent today the smooth functioning of the fixed exchange rate system is not possible.

For example the european exchange rate mechanism erm was a semi fixed exchange rate system. In this article we will discuss about the advantages and disadvantages of floating exchange rates. A metallic standard is considered to promote price stability.

This helps to promote international trade whereas one of the main disadvantage is that the prices were more flexible. However some studies indicate that the gold standard era experienced large fluctuations in the average price level. Fixed or stable exchange rates ensure certainty about the foreign payments and inspire confidence among the importers and exporters.

Advantages of fixed exchange rates. Before looking at these disadvantages question some of the advantages of fixed exchange rates. Floating exchange rates have the following advantages.

During the decades immediately following world war ii the advantages of fixed exchange rates proved less powerful than earlier presumed. Any undue fluctuations in exchange rate cause problems to the plans and programmes of both exporters and imports. Often countries join a semi fixed exchange rate where the currency can fluctuate within a small target level.

Any disequilibrium in the balance of pay ments would be automatically corrected by a change in the exchange rate. Moreover various theoretical developments argued for freely floating rather than fixed or managed exchange rate systems and better highlighted the following disadvantages of a fixed exchange rate. The necessary condition for an orderly and steady growth of trade demands stability in exchange rate.

Let us make an in depth study of the advantages and disadvantages of the fixed exchange rate system. Advantage of floating exchange rates.