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Floating vs. Fixed Exchange Rates

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In the past, the value of currency was determined on the basis of the value of gold. Over a period of time, the temptation to return to a gold standard has been raised and debated. A fixed rate of exchange has the risks associated with the exchange rates and fiscal policies. In contrast, floating rates introduce new opportunities to countries.

Tasks:
Both floating and fixed exchange rate systems have benefits. Summarize briefly the advantages and disadvantages of each system.
Do you think the world will move toward an international monetary system or fixed exchange rates in the future? Provide reasons to support your answer.

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Solution Summary

This solution discusses the use of floating vs. fixed exchange rates.

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Both the floating and fixed exchange rate systems belong to the international exchange rate system. In respect to the floating exchange rate system, a country's currency is valued according to its demand and supply in exchange for another country's currency within a private market that is operated by major international banks. On the other hand, the fixed exchange rate system occurs when a country's government makes a public announcement of what its country's currency will be worth in comparison to something, in what is known as the rules of exchange. The comparison could be to gold, to another country's currency, etc (Suranovic, 2009).

In favor of the floating exchange rate system, it has better adjustment due to the forces of demand and supply. This means that a true value is derived as a result of the ease in adjustment, giving a true reflection of the intrinsic value of a currency. The floating exchange rate system is also seen to have more confidence and create it as such within the market. When there lacks a monopoly dictating the value, people tend to perceive the currency as a true reflector of value that is unbiased. This exchange rate system also has the advantage of having better liquidity. This liquidity is brought about due to the availability of a ready market that naturally occurs when there exists a free flowing ...

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