Difference between fixed and variable exchange rates

Fixed Exchange Rate: A fixed exchange rate system is a system in which a country's national currency (such as the dollar, euro, pound sterling) is valued at a fixed rate against another currency (usually the US dollar). This rate is usually set by the government or central bank and is not changed. Fixed exchange rate systems aim to keep the values of currencies stable.

Advantages:

• It can help facilitate trade by ensuring stable prices in export and import transactions.
• Investors and businesses are not affected by large fluctuations in exchange rates, thus reducing risk.

Challenges:

• When economic conditions change, fixed exchange rate systems can be difficult to adjust.
• In practice, balancing monetary policy and exchange rate objectives can be difficult.

Floating Exchange Rate: Floating exchange rate system is a system in which exchange rates are determined according to supply and demand factors under free market conditions. The exchange rate may change constantly depending on the amount of foreign currency traded in the market and the demand for foreign currency.

Advantages:

• Exchange rates can better adapt to economic conditions.
• Central banks may have the flexibility to maintain economic stability by using monetary policy tools.

Challenges:

• Fluctuations in exchange rates can make export and import transactions difficult.
• Investors and businesses may face risks due to uncertainty in exchange rates.

Why Are There Differences? The choice of fixed or floating exchange rate systems depends on a country's economic structure, goals and policies. While some countries consider the advantages of fixed exchange rates to provide economic stability, others may prefer a floating exchange rate system due to economic flexibility and adaptability.

Fixed and floating exchange rate systems are the basic building blocks of the international financial system. Both systems come with their advantages and challenges and may be preferred based on a country's economic goals, policies and conditions.