Fixed Exchange Rate
What Is a Fixed Exchange Rate?
A fixed exchange rate is a system applied by a government or central bank that ties the country's official currency exchange rate to one more nation's currency or the price of gold. The purpose of a fixed exchange rate system is to keep a currency's value inside a narrow band.
Understanding a Fixed Exchange Rate
Fixed rates give greater certainty to [exporters](/send out) and importers. Fixed rates additionally assist the government with keeping up with low inflation, which, over the long haul, keep interest rates down and invigorates trade and investment.
Most major industrialized nations have had floating exchange rate systems, where the going price on the foreign exchange market (forex) sets its currency price. This practice started for these nations in the mid 1970s while creating economies go on with fixed-rate systems.
Bretton Woods
From the finish of World War II to the mid 1970s, the Bretton Woods Agreement implied that the exchange rates of participating nations were pegged to the value of the U.S. dollar, which was fixed to the price of gold.
At the point when the United States' postwar balance of payments surplus went to a deficit during the 1950s and 1960s, the periodic exchange rate adjustments permitted under the agreement eventually proved inadequate. In 1973, President Richard Nixon eliminated the United States from the gold standard, introducing the period of floating rates.
The Beginnings of the Monetary Union
The European exchange rate mechanism (ERM) was laid out in 1979 as a forerunner to monetary union and the presentation of the euro. Member nations, including Germany, France, the Netherlands, Belgium, and Italy, agreed to keep up with their currency rates inside plus or minus 2.25% of a central point.
The United Kingdom participated in October 1990 at an unreasonably strong conversion rate and was forced to pull out two years after the fact. The original members of the euro changed over from their home currencies at their then-current ERM central rate as of Jan. 1, 1999. The euro itself trades unreservedly against other major currencies while the currencies of countries wanting to join trade in a managed float known as ERM II.
Detriments of Fixed Exchange Rates
Creating economies frequently utilize a fixed-rate system to limit speculation and give a stable system. A stable system allows merchants, exporters, and investors to plan without stressing over currency moves.
Notwithstanding, a fixed-rate system limits a central bank's ability to change interest rates depending on the situation for economic growth. A fixed-rate system likewise forestalls market adjustments when a currency becomes over or undervalued. Effective management of a fixed-rate system likewise requires a large pool of reserves to support the currency when it is feeling the squeeze.
A ridiculous official exchange rate can likewise lead to the development of a parallel, unofficial, or dual, exchange rate. A large gap among official and unofficial rates can redirect hard currency from the central bank, which can lead to forex deficiencies and periodic large devaluations. These can be more disruptive to an economy than the periodic adjustment of a floating exchange rate system.
Certifiable Example of a Fixed Exchange Rate
Issues of a Fixed Exchange Rate Regime
In 2018, as per BBC News, Iran set a fixed exchange rate of 42,000 rials to the dollar, in the wake of losing 8% against the dollar in a single day. The government chose to eliminate the error between the rate traders utilized — 60,000 rials — and the official rate, which, at that point, was 37,000.
Features
- Many industrialized nations started utilizing the floating exchange rate system in the mid 1970s.
- Fixed exchange rates give greater certainty to exporters and merchants and assist the government with keeping up with low inflation.
- The purpose of a fixed exchange rate system is to keep a currency's value inside a narrow band.
