What are the types of exchange rates?
In this post, we have written What are the types of exchange rates.
Some of the major types of foreign exchange rates are the following:
1. FIXED EXCHANGE RATE
A fixed exchange rate also referred to as the pegged exchange rate, is “pegged” or connected to another currency or asset often gold to get its value. This kind of exchange rate mechanism makes sure the stability of the exchange rates by linking it to a well-balanced currency itself. Also, a fixed currency system is almost well protected against the quick fluctuations in inflation. Some countries adhering to a fixed-rate system include the Bahamas, Denmark, Saudi Arabia, and Hong Kong.
Advantage: A country with a fixed exchange rate system is appealing to foreign investors who’re tempted to invest in that country because of the stability it offers.
Disadvantage: The government of a country following this type of system has to keep a large number of foreign exchanges or gold reserves to keep its value. This system, therefore, proves to be a costly one.
2. FLEXIBLE EXCHANGE RATE
Flexible or Floating exchange rate systems are ones through which the rate of a currency is determined by the market forces fo supply and demand. Unlike the fixed exchange rate they cannot get their value from any underlying. Some economists assert that the floating system is better because it absorbs the shocks of a worldwide crisis and automatically changes to reach an equilibrium.
The central bank of the country might interfere in economically utmost situations like the recession or boom to stabilize the currency. They could buy or sell an amount of the currency to stop the rates from going haywire. This phenomenon is called the managed float.
3. Managed Floating Rate System
Why is the exchange rate important?
Apart from factors like interest rates and inflation, the currency exchange rate is among the most important determinants of a country’s relative degree of economic health. A higher-valued currency makes a country’s imports more affordable and its exports more costly in foreign markets.
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