Page 213 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 18 : Merits and Demerits of Fixed and Flexible Exchange Rate

• In fact, a regime of fixed exchange rates presupposes uniformity of domestic policy objectives Notes
and response of prices to fluctuations in demand. Such a system would undoubtedly run into
severe difficulties in the present-day world. This is because there is a reluctance to be committed
to the harmonisation of domestic policy objectives; prices respond only in a limited fashion of
fluctuations in the pressures of demand, and elasticities of demand in international trade have
in general turned out to be quite low, at least in the short run.
18.4 Key-Words

1. Fixed exchange rate : A fixed exchange rate, sometimes called a pegged exchange rate, is also
referred to as the Tag of particular Rate, which is a type of exchange
rate regime where a currency's value is fixed against the value of another
single currency or to a basket of other currencies, or to another measure
of value, such as gold.
A fixed exchange rate is usually used to stabilize the value of a currency
against the currency it is pegged to. This makes trade and investments
between the two countries easier and more predictable and is especially
useful for small economies in which external trade forms a large part of
their GDP.
2. Flexible exchange rate : A flexible exchange-rate system is a monetary system that allows the
exchange rate to be determined by supply and demand. Every currency
area must decide what type of exchange rate arrangement to maintain.
Between permanently fixed and completely flexible however, are
heterogeneous approaches.
18.5 Review Questions

1. What do mean by fixed exchange rate?
2. Explain the merits and demerits of fixed exchange rate.
3. Discuss Filexible exchange rate.
Answers: Self-Assessment
1. (i)(b) (ii)(c) (iii)(c) (iv)(c) (v) (c)
18.6 Further Readings

1. Dornbusch, Rudiger and Stanley Fischer (1980). \Exchange Rates and the Current
Account." American Economic Review 70, 960 {71.
2. Frenkel, Jacob A. and Michael L. Mussa (1985). \Asset Markets, Exchange Rates,
and the Balance of Payments: The Reformulation of Doctrine." See Jones and
Kenen (1985), pp. 679{747.
3. Isaac, Alan G. (1989). \Wealth E_ects and the Current Account with Endogenous
Terms of Trade." Journal of Macroeconomics 11(4), xxx.
4. Jones, Ronald W. and Peter B. Kenen, eds. (1985). Handbook of International
Economics, Volume 2. Amsterdam: North Holland Publishing Co.
5. Kenen, Peter (1985). \Macroeconomic Theory and Policy: How the Closed
Economy was Opened." See Jones and Kenen (1985), Chapter 13, pp. 625{677.
6. Kouri, Pentti J.K. (1976, May). \The Exchange Rate and the Balance of Payments
in the Short Run and the Long Run: A Monetary Approach." Scandinavian Journal
of Economics 78(2), 280{304.

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