What is a fixed and variable exchange rate?
A fixed exchange rate denotes a
A fixed exchange rate is a regime imposed by a government or central bank which ties the official exchange rate of the country's currency with the currency of another country or the gold price.
Fixed exchange rates are determined by a government or central bank and typically involve pegging the currency of one country to that of another country or a basket of currencies. Flexible exchange rates, on the other hand, are determined by the market forces of supply and demand.
Exchange rates of a currency can be either fixed or floating. Fixed exchange rate is determined by the central bank of the country while the floating rate is determined by the dynamics of market demand and supply.
It allows you to determine how much of one currency you can trade for another. For example, if you go to Saudi Arabia, you always know a dollar will buy you 3.75 Saudi riyals, since the dollar's exchange rate in riyals is fixed. Saudi Arabia did that because its primary export, oil, is priced in U.S. dollars.
For example, the United Arab Emirates pegs its currency, the UAE dirham, to 0.27 United States dollar. In other words, for 1 USD, you will always get 3.67 dirhams. It was done to provide stability in the oil trade between the two countries.
A pegged rate, or fixed exchange rate, can keep a country's exchange rate low, helping with exports. Conversely, pegged rates can sometimes lead to higher long-term inflation. Maintaining a pegged exchange rate usually requires a large amount of capital reserves.
The purpose of a fixed exchange rate system is to keep a currency's value within a narrow band. Fixed exchange rates provide greater certainty for exporters and importers and help the government maintain low inflation.
By pegging one currency to another, there's less fluctuation when exchanging money or trading between countries. Currencies with fixed exchange rates are therefore more stable and less influenced by market conditions than currencies with floating exchange rates.
- Stability and Predictability: Fixed exchange rates offer stability and predictability for businesses engaged in international trade. ...
- Inflation Control: Fixed exchange rates can help control inflation, as they limit the central bank's ability to print excessive money to finance government deficits.
What is the strongest exchange rate?
1. Kuwaiti dinar (KWD) The Kuwaiti dinar is the strongest currency in the world with 1 Kuwaiti dinar buying 3.26 US dollars (or, put another way, US$1 equals 0.31 Kuwaiti dinars). Kuwait is located between Saudi Arabia and Iraq, earning much of its wealth from being a leading global exporter of oil.
In the modern world, most of the world's currencies are floating, and include the most widely traded currencies: the United States dollar, the euro, the Swiss franc, the Indian rupee, the pound sterling, the Japanese yen, and the Australian dollar.
The exchange rate gives the relative value of one currency against another currency. An exchange rate GBP/USD of two, for example, indicates that one pound will buy two U.S. dollars. The U.S. dollar is the most commonly used reference currency, which means other currencies are usually quoted against the U.S. dollar.
| Fixed currency | Reference currency | Rate (reference / fixed) |
|---|---|---|
| Qatari riyal | U.S. dollar | 3.64 |
| Saint Helena pound | Pound sterling | 1 |
| São Tomé and Príncipe dobra | Euro | 24.50 |
| Saudi riyal | U.S. dollar | 3.75 |
There are two types of currency exchange rates—floating and fixed. The U.S. dollar and other major currencies are floating currencies—their values change according to how the currency trades on forex markets. Fixed currencies derive value by being fixed or pegged to another currency.
The U.S. dollar is a floating currency, much like most of the major currencies in the world.
The fixed exchange rate regime demands strict monetary discipline by the government. The government, actually, gives up its freedom of choice in monetary policy, which is the only option that becomes the one necessary to maintain the exchange rate fixed.
If you don't know the exchange rate, you can use the following simple currency conversion calculation to find it: take your starting amount (original currency) and divide it by ending amount (new currency) = exchange rate.
In part, low inflation is associated with fixed exchange rates because countries with low inflation are better able to maintain an exchange rate peg. But there is also evidence of causality in the other direction: countries that choose fixed exchange rates achieve lower inflation.
Higher demand means higher value, while lower demand means lower value. Using a floating currency can be considered a fiscal benefit when the economy is strong and fiscal policy is sound. But, if market sentiment towards the government and its monetary policy is weakened, it could lead to a devaluation of its currency.
What are the problems with fixed exchange rates?
Drawbacks of Fully Fixed Exchange Rates:
Balance of Payments Issues: In a fixed exchange rate system, a country's balance of payments must be maintained through other means, such as fiscal policy or controls on capital flows. Persistent imbalances can lead to pressures on the currency peg.
In a fixed exchange rate system, it becomes the responsibility of the central bank to maintain this balance. The central bank can intervene in the private foreign exchange (Forex) market whenever needed by acting as a buyer and seller of currency of last resort.
Probably the best reason to adopt a fixed exchange rate system is whenever a central bank has been independently unable to maintain prudent monetary policy, leading to a reasonably low inflation rate.
Fluctuating fixed exchange rate systems will create unwanted hurdles in the process of economic growth of these economies. One of the advantages of the fixed exchange system is that it dissuades the countries' governments from undertaking inflationary policies.
A fixed exchange rate denotes a nominal exchange rate that is set firmly by the monetary authority with respect to a foreign currency or a basket of foreign currencies. By contrast, a floating exchange rate is determined in foreign exchange markets depending on demand and supply, and it generally fluctuates constantly.
