What is the fixed exchange rate?
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.
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.
Key Takeaways. 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.
Fixed Exchange Rates: An exchange rate system where exchange rates are fixed by the central bank of each country. Floating Exchange Rates: An exchange rate system where exchange rates are determined entirely by market forces.
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.
| Fixed currency | Reference currency | Rate (reference / fixed) |
|---|---|---|
| Saudi riyal | U.S. dollar | 3.75 |
| Swazi lilangeni | South African rand | 1 |
| Tuvaluan dollar | Australian dollar | 1 |
| United Arab Emirates dirham | U.S. dollar | 3.6725 |
The exchange rate can be fixed by either the government or its central bank. They set the rate: the upper and lower limits that the exchange rate can move between. The central bank is responsible for maintaining the exchange rate at the rate decided.
A fixed exchange rate helps to ensure the smooth flow of money from one country to another. It helps smaller and less developed countries to attract foreign investment. It also helps the smaller countries to avoid devaluation of their currency and keep inflation stable.
1. Kuwaiti dinar. Known as the strongest currency in the world, the Kuwaiti dinar or KWD was introduced in 1960 and was initially equivalent to one pound sterling. Kuwait is a small country that is nestled between Iraq and Saudi Arabia whose wealth has been driven largely by its large global exports of oil.
- Ugandan Shilling (USH) ...
- Colombian Peso (COP) ...
- Cambodian Riel (KHR) ...
- Malagasy Ariary (MGA) ...
- Paraguayan Guarani (PYG) 1 USD = 7,283.00 PYG. ...
- Guinean Franc (GNF) 1 USD = 8,593.11 GNF. ...
- Uzbekestani Som (UZS) 1 USD = 12,339.85 UZS. ...
- Lebanese Pound (LBP) 1 USD = 15,023.74 LBP.
What are the two types of fixed exchange rates?
The two major types of fixed exchange rate regimes were the gold standard and Bretton Woods. The gold standard relied on retail convertibility of gold, while the BWS relied on central bank management where the USD stood as a sort of substitute for gold.
In fixed exchange rate or currency board regimes, the exchange rate ceases to vary in relation to the reference currency. In a dollarization regime, there is not really an exchange rate, given that the domestic currency ceases to exist. A country that adopts one of these regimes ceases to have monetary policy autonomy.
This occurs when the government seeks to keep the value of a currency fixed against another currency. Semi-Fixed Exchange Rate. This occurs when the government seeks to keep the value of a currency between a band of the exchange rate. In other words, the exchange rate can fluctuate within a narrow band.
- Preventing adjustments for currencies that become under- or over-valued.
- Limiting the extent to which central banks can adjust interest rates for economic growth.
- Requiring a large pool of reserves to support the currency if it comes under pressure.
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.
A fixed exchange rate (also known as the gold standard) quantifies the values of currencies by using a stable reference point. Historically, gold has been used as the reference point. This is because it is a valuable commodity worldwide and its value is less susceptible to fluctuations in interest rates.
Understanding a Fixed Exchange Rate
Fixed rates provide greater certainty for exporters and importers. Fixed rates also help the government maintain low inflation, which, in the long run, keep interest rates down and stimulates trade and investment.
A cornerstone of China's economic policy is managing the yuan exchange rate to benefit its exports. China does not have a floating exchange rate that is determined by market forces, as is the case with most advanced economies. Instead it pegs its currency, the yuan (or renminbi), to the U.S. dollar.
A fixed or pegged rate is determined by the government through its central bank. The rate is set against another major world currency (such as the U.S. dollar, euro, or yen). To maintain its exchange rate, the government will buy and sell its own currency against the currency to which it is pegged.
Thus, fixed exchange rates force the central bank to pursue a monetary policy that acts as a multiplier for the effect of growth shocks. In a recession, the money supply is reduced, which additionally burdens the economy. Whereas in a boom the money supply is increased, which additionally fuels the economy.
Why fixed exchange rate collapsed?
In February 1973, the fixed exchange rate system collapsed when the major currencies moved to a float. The floating exchange rate system has been in place ever since. In retrospect, I believe that the U.S. carried out three "Nixon shocks" in 1971.
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.
The merits have been stated below. Price Stability: Fixed exchange rates provide price stability, making it easier for businesses to plan and budget for international trade. Reduced Currency Risk: Businesses and investors can hedge against currency risk more effectively in a fixed exchange rate system.
In a floating regime, exchange rates are generally determined by the market forces of supply and demand for foreign exchange.
What country is a dollar worth most? Some of the countries where a dollar is worth the most money include Mexico, Peru, Chile, and Colombia. It's possible to exchange dollars for local currency in these countries at favorable exchange rates.
