A type of exchange rate regime wherein a currency’s value is permitted to fluctuate according to the foreign exchange market is referred to a floating exchange rate or a flexible exchange rate. A floating currency is a currency that uses a floating exchange rate. Fixed exchange rate is the opposite of a floating exchange rate.
Floating exchange rate are preferred as compared to Floating exchange rate
It is being thought by economists that, in most circumstances, traders prefer to use floating exchange rates as compared to fixed exchange rates. As there is an automatic adjustment in the floating exchange rates, so with it is possible for a country to dampen the impact of shocks and foreign business cycles, and it also helps a country to preempt the possibility of having a balance of payments crisis.
Despite of all the facts, in certain circumstances, fixed exchange rates may be preferable due to their greater stability and certainty. May be it is not necessarily true, if we consider the results of countries that have made attempts to keep the prices of their currency “strong” or “high” relative to others, such as the UK or the Southeast Asia countries before the Asian currency crisis.
Mundell-Fleming Model
Mundell-Fleming model has set forth the debate of making a choice between fixed and floating exchange rate regimes, model argues that it is not possible for an economy to simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. Only it has the choice that it can select any two for control, and has to leave the third one to the market forces.
A central bank will normally intervene to stabilize the currency in cases of extreme appreciation or depreciation. Thus, the exchange rate regimes of floating currencies may be more technically referred to as a managed float. For instance, it might be allowed by a central bank to float freely between an upper and lower bound, a price “ceiling” and “floor”. In order to provide price support or resistance, management by the central bank may take the form of buying or selling large lots,or, in the case of some national currencies, there might be some legal penalties for trading outside these bounds.
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