Exchange rates fluctuate under both the fixed exchange rate and floating exchange rate systems. What, then, is the difference between the two systems?

Exchange rates fluctuate under both the fixed exchange rate and floating exchange rate systems. What, then, is the difference between the two systems?

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Exchange rates fluctuate under both the fixed exchange rate and floating exchange rate systems. What, then, is the difference between the two systems?

Answer and ExplanationSolution by a verified expert
Sample Response Fixed exchange rate system is a system where the central bank of the country uses an open market mechanism and is responsible to buy or sell the country's currency at a fixed pric...

Sample Response

Fixed exchange rate system is a system where the central bank of the country uses an open market mechanism and is responsible to buy or sell the country's currency at a fixed price, in order to maintain its pegged ratio. When a country attaches the currency with some security like gold or the currency of another country like the dollar, it is called pegging. Thus, fluctuation of exchange rate under this system was limited to change in gold reserves or change in foreign currency reserves. The maximum fluctuation was about +1% or -1%.
 
Floating exchange rate is that rate of exchange which is determined by two countries based on relative demand and supply forces for their currencies. Thus, the actual percentage change in exchange rate depends on the amount of change in bilateral trade. The imports and exports between the countries depends on various factors and can vary substantially for different periods. As a result, exchange rate fluctuation under the floating rate system is not restricted to any certain limit.
 
Fixed exchange rate was adopted by the countries previously. The magnitude of international transactions was not huge at that time. However, as the time progressed, most of the developed countries started following the floating exchange rates.
 
Hence, though there is fluctuation under both the exchange rate systems, there is a huge difference between the quantum of fluctuation.

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