Distinguish between fixed exchange rate and flexible foreign exchange rate

What is fixed exchange rate?

Fixed exchange rate is a system in which the value of one country’s currency is fixed against another. It sets the exchange rate at an agreed-upon price and does not allow that rate to fluctuate even if economic circumstances change. In most cases, a government will choose a fixed or semi-fixed exchange-rate system when it wants to protect its currency from devaluation.

What is flexible foreign exchange rate?

The foreign exchange rate is said to be flexible when the value of one country’s currency fluctuates depending on economic circumstances. It may rise or fall according to inflation, interest rates and other factors. The central bank does not intervene in its value unless it becomes extremely volatile (or ‘unruly’).

Distinguish between fixed exchange rate and flexible foreign exchange rate

1. Fixed exchange rate can be defined as a system in which the value of one country’s currency is fixed against another. It sets the exchange rate at an agreed-upon price and does not allow that rate to fluctuate even if economic circumstances change. Flexible foreign exchange on the other hand, is used for all currencies that can fluctuate in value, but is typically used for currencies of developing countries.




2. In a fixed exchange rate system the exchange rate is set by the government and it does not allow that rate to fluctuate even if economic circumstances change. However, in flexible foreign exchange the central bank intervenes only when there is a run on the currency.
3. In the fixed exchange rate system, the government controls the value of its currency by changing its foreign-exchange reserves or tightening its domestic money supply to prevent large exchange rate fluctuations. On the other hand, in flexible foreign exchange rate, central bank involvement is limited to keeping inflation under control and the foreign exchange rate is allowed to fluctuate as a result.