This range could be very small i.e., 2% on either side of it could be as large as 75% on either side. However, as soon as the limit is breached, the central bank takes swift action. If the value of the currency fluctuates within this limit, then the central bank takes no action. Instead, these countries choose a range that has an upper and lower limit. Maintaining an absolute peg is very difficult from an operational point of view. In practice, countries do not really have absolute peg. Once the exchange rate is fixed, it is the job of the central bank to ensure that the price changes in the underlying currency closely mirror the price changes in the target with a small margin for error (usually +/- 1%) Lastly, the exchange rate of one currency could be fixed in relation to the price of a precious metal such as gold. However, a fixed exchange rate is a conservative system that is generally used by conservative countries such as China.įor instance, the exchange rate of one currency i.e., the Chinese Yuan, could be fixed in relation to another currency such as the United States dollar.Īlternatively, the exchange rate of one currency could be fixed in relation to a basket of currencies such as the Euro, the dollar, the yen, etc. The exchange rate of this currency can be fixed in various ways. Instead, it is determined by the central bank. Fixed Exchange Rate: A fixed exchange rate is a system in which the exchange rate of a currency is not determined by the market.This will help us understand why certain types of economies prefer certain exchange rate regimes. Lets have a closer look at these systems one by one. Each of these systems is commonly associated with the degree of liberalization of the underlying economy. However, these two systems have several variations within them. the fixed regime and the floating regime. In reality, there are only two types of exchange rate regimes, which are possible viz. The differences in the different types of exchange rate regimes, as well as how they impact the economy, have been listed down in this article. For instance, the exchange rate system in a country like China is remarkably different from the exchange rate system in a country like the United States. However, the reality is that these regimes are significantly different from one another. To a layman, all exchange rate regimes might appear to be similar. It is for this reason that the choice of the type of exchange rate regimes is very important. Also, international trade is highly dependent upon exchange rates. International trade is a vital component of the economy of any nation.
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