Major Currencies Questions Medium
A fixed exchange rate refers to a system where the value of a currency is set and maintained by the government or central bank. In this system, the exchange rate is fixed against another currency, a basket of currencies, or a commodity such as gold. The government or central bank intervenes in the foreign exchange market to ensure that the exchange rate remains constant or within a narrow range.
On the other hand, a floating exchange rate, also known as a flexible exchange rate, is determined by the forces of supply and demand in the foreign exchange market. Under this system, the exchange rate fluctuates freely based on various factors such as economic conditions, interest rates, inflation, and market speculation. The government or central bank does not actively intervene to control or stabilize the exchange rate.
The main difference between a fixed and floating exchange rate is the level of control exerted by the government or central bank. In a fixed exchange rate system, the authorities actively manage the exchange rate to maintain stability, which can help promote trade and investment but may limit the ability to respond to economic shocks. In contrast, a floating exchange rate allows for greater flexibility and adjustment to market conditions, but it can also lead to volatility and uncertainty in international trade and investment.