Question

In a few sentences, explain the difference between a fixed exchange rate and a flexible exchange rate. What are the basic advantages and disadvantages of each?

Answer 1

Answer:

Explanation

A fixed exchange rate happens when a country ties the value of its currency to some other common commodity or to the currency of another  i.e  an exchange rate where the currency of one country is linked to the currency of another country or a commonly traded commodity like gold or oil.  It provides country stability and the rate are predominantly determined by the government.

while Flexible exchange rate which is also known as floating exchange rate  serves to adjust the balance of trade. In this exchange, the currency price of a nation is set by the forex market based on supply and demand relative to other currencies. Unlike Fixed exchange, where exchange rates are determined by government, exchange rate is solely determined by the global demand and supply of currencies in Flexible exchange.

advantages of fixed exchange;

1.  it provides country stability as the investors always know the  worth of the currencies.

2. it prevent inflation from occurring in a country.

3.  It promotes currency stability.

disadvantages:

1. It can be very expensive to maintain as a country must have enough foreign  exchange reserves to manage its currency rate.

2. it require higher interest rates.

advantages of flexible exchange:

1. it promotes stability in the balance of payment

2. promotes the domestic economy from shocks produced by disturbances

disadvantages:

1.  unstable conditions

2.  volatile in nature