Question

Give arguments for and against fixed rate of exchange.

State arguments for and against fixed rate of exchange.

Answer 1

Arguments in Favour of Fixed Exchange Rate:

1. Stability in Trade: Fixed rates make international trade and investment more predictable and less risky.
2. Control Over Inflation: A stable currency helps control rising prices and maintains purchasing power.
3. Builds Investor Confidence: Foreign investors feel safer investing in a country with a stable exchange rate.
4. Avoids Speculation: Since the rate doesn’t change, there’s less chance for currency speculation.

Arguments Against Fixed Exchange Rate:

1. Difficult to Maintain: It’s hard for a country to keep a fixed rate during economic problems.
2. Loss of Monetary Freedom: The government can’t freely use monetary policies (like changing interest rates) to solve domestic issues.
3. Can Create Black Markets: If the fixed rate is unrealistic, people may trade currency illegally at different rates.
4. Risk of Currency Crisis: If the central bank runs out of reserves to maintain the rate, it may lead to a financial crisis.