The paper 'Fixed and Floating Exchange Rates" is an outstanding example of a finance and accounting coursework. The question of whether a country should decide on adopting a flexible or fixed exchange rate is one of the major policy concerns of any economy. Many countries have either encountered a crisis that interrupted their growth because they made a wrong choice or because of misguided decisions, others have not experienced growth. However, this is not to say that the exchange rate policy is the only thing that counts, but the distorting exchange rate policy could affect the entire economy negatively. FIXED AND FLOATING EXCHANGE RATES According to Summers one of the fundamental propositions in recent studies on exchange rate regimes is that under free capital mobility, the exchange rate regime determines the ability to undertake independent monetary policy.
A fixed regime implies giving up monetary independence while a floating regime allows for a national monetary policy. (Summers 2000) According to CRS Report Congress, floating exchange rate lets the market dynamics to determine the exchange rate. In states that permit their exchange rates regime to float the central bank intervenes regularly to limit short-term exchange rate fluctuations in a bid to control inflation.
Almost all advanced economies and most large emerging market countries have floating exchange rate systems in place. Floating exchange rates offer countries an opportunity to make central banks independent in making monetary policies. Through financial instruments, the central bank hedges out the risks posed by fluctuating exchange rates for this to be effective the financial markets have to strong enough to withstand shocks without large exchange rate intervention to make these monetary policies effective.
In a pure fixed exchange rate regime, the central bank buys or sells any amount of currency at a predetermined rate. That rate may be linked to one or more foreign currencies. Countries, where capital is perfectly dynamic investors, consider all other countries alike, theoretically fixed exchange rates would necessarily be functionally equivalent to a currency board. Any unilaterally attempt to influences interest rates, through monetary or fiscal policy, would be unsustainable because capital would flow in or out of the country until interest rates have returned to the worldwide level.
(CRS Report Congress 2004) BENEFITS AND COST OF FIXED AND FLOATING EXCHANGE RATES According to Eichengreen and group, floating exchange rates usually targets to control inflation, though there are answered concerns of business investors as to whether the monetary policies that target inflation do work in a freely floating exchange rate and how effective it is in promoting business investments in many developing and transition economies. These countries are subject to a substantial amount of internal and external shocks and the transfer methods through which monetary policy affects the economy and the price level tend to be unpredictable and reliable.
(Eichengreen et al 1998) Friedman suggested that flexible exchange rates help protect the economy against shocks. Evidence indicates that floating exchange rates could be quite volatile leading to uncertainty about future profits in the traded-goods industries. This makes firms hold on before hiring new workers when demand is high and firing existing ones when demand is low. (Friedman 1953)
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