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Fixed Exchange Rate System - Introduction: Monetary Discipline

The document discusses fixed and floating exchange rate systems. Under a fixed exchange rate system, currency values are set against each other at predetermined rates to provide certainty. Merits include monetary discipline, reduced speculation, and certainty for financial planning. However, critics argue it limits monetary policy autonomy. A floating rate system allows currency rates to fluctuate based on supply and demand. This gives more autonomy over monetary policy and allows trade balances and crisis recovery to be adjusted through rate changes. For a company like JCB, a floating rate may be more suitable given limitations of fixed rates in preventing speculation and the need for consistent economic policies under floating rates.

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20 views

Fixed Exchange Rate System - Introduction: Monetary Discipline

The document discusses fixed and floating exchange rate systems. Under a fixed exchange rate system, currency values are set against each other at predetermined rates to provide certainty. Merits include monetary discipline, reduced speculation, and certainty for financial planning. However, critics argue it limits monetary policy autonomy. A floating rate system allows currency rates to fluctuate based on supply and demand. This gives more autonomy over monetary policy and allows trade balances and crisis recovery to be adjusted through rate changes. For a company like JCB, a floating rate may be more suitable given limitations of fixed rates in preventing speculation and the need for consistent economic policies under floating rates.

Uploaded by

UmairAfzal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Fixed Exchange Rate System – Introduction

According to [ CITATION Hill \l 1033 ] in fixed exchange rate system the values of a set of currencies are
fixed against each other at predetermined mutually agreed exchange rate. The main objective of fixed
exchange rate system is to bring certainty in exchange rates and to keep a country’s currency value
stable [ CITATION CHR19 \l 1033 ]. This system historically provided certainly financial transactions
specially in terms of imports and exports.

Fixed Exchange Rate System – Merits


There are four main elements in support of fixed exchange rate system [ CITATION Hill \l 1033 ]:

Monetary Discipline

Better control over a country’s monetary system is one of the merits of fixed exchange rate system.
Government will be restricted to follow undesirable policies due to political pressure in the presence of
fixed exchange rate system. Moreover, expansion of money supply by the Government at inflationary
rate will be curtailed.

Speculation

According to supporter of fixed exchange rate system [ CITATION Hill \l 1033 ], historically exchange
rates change, not due to real economic reason but purely based upon speculation. Foreign exchange
traders manipulate currency rates in order to get short-term benefits due to movement in exchange
rates. This eventually resulted in speculation in foreign exchange market. Fixed exchange rate system
discourages such manipulation and limit the destabilization effect due to speculation.

Uncertainty

Due to fixed exchange rate system the exchange rate is always known. This will make financial decision
making by firm to be more certain and less risky. As discussed earlier floating exchange rate system
encourages speculation which eventually results in uncertainty. Fixed exchange rate system encourages
consistent financial planning by firms and brings less risk in various business activities e.g. imports,
exports and foreign investment. Unlike fixed exchange rate system, floating rate system adversely
impacts international trade and investments.

Trade Balance Adjustments and Economic Recovery

According to [ CITATION Hill \l 1033 ], supports fixed exchange rate system reject the claim that there is
link between trade balance adjustments and economic crisis recovery. As per them trade deficit and
economic growth has nothing to do with foreign exchange rate and external value of currency.
Furthermore, the supports of fixed exchange rate system do not believe that currency depreciation
boost exports and curtail imports. In fact, the downside of currency depreciation is inflation.

Floating Exchange Rate System – Introduction


As explained by [ CITATION Hill \l 1033 ] floating exchange rate system does not fix exchange rate.
Exchange rate between a country’s currency is determined by foreign exchange market through the
forces of demand and suppl with respect to other country’s currency. In other words, unlike fixed
exchange rate system there is little or no role of Government to set exchange rate.

Floating Exchange Rate System – Merits


The supports of floating exchange rate system put forward following merits [ CITATION Hill \l 1033 ]:

Monetary Policy Autonomy

A country has to maintain exchange rate parity under fixed exchange rate system in order to bring
certainly and discourage speculation. The downside of this approach is limitation on expansion or
contrition in money supply to maintain exchange rate parity. Monetary expansion will lead towards
inflation which will result in downward pressure on fixed exchange rate. In other words, a country will
be limited to use monetary policy in order to expand or contract. Floating exchange rate system restores
monetary control of a government. For example, government can increase money supply to stimulate
demand in order to reduce unemployment without any restriction to maintain a specific exchange rate.

Trade Balance Adjustments

Supporters of floating exchange rate system argue that trade balance deficit (imports more then
exports) can more smoothly corrected and adjusted due to floating exchange rate system. It would be
possible to correct or adjust this trade balance deficit only though domestic policies. Under floating
exchange rate system trade deficit can be compensated by depreciating foreign exchange rate of that
country. Currency deprivation will make exports cheaper and imports expensive, thereby correction of
trade balance deficit.

Crisis Recovery

A country’s economy is exposed to multiple internal and external challenges. Those in support of
floating exchange rate system argue that exchange rate adjustments can help a country to deal and
recover from crisis[ CITATION Hill \l 1033 ]. Thanks to floating exchange rate system, the exchange rate
of a country will respond and correct itself in order to absorb the external shocks to economy. In
contrast the rigid nature of fixed exchange rate system does not allow such exchange rate adjustments
and corrections.

Fixed Vs Floating Exchange Rate System – JCB Prospective


It is important for JCB management to understand the influence of exchange rates on the overall
profitability and return on investment [ CITATION Hill \l 1033 ]. The impact of adverse movements in the
exchange rate between and Indian Rupee (INR) and British Pound (GBP) cannot be underestimated.

Since 1990s India is following floating / market based foreign exchange rate [ CITATION Him19 \l 1033 ].
Which means that forces of demand and supply determine the exchange rate of Indian Rupee (INR) with
other currencies of the world.

There are multiple factors which can contribute towards choice between fixed exchange rate system
and floating exchange rate system.
From JCB prospective speculation is one of the most important criteria while choosing fixed or floating
exchange rate system. According to [ CITATION Hill \l 1033 ] currency exchange rates cannot be free
from speculation even in case of fixed exchange rate system. In order words, foreign exchange rates are
subject to speculation even if fixed exchange rate system is being used. In other words, one of the most
important advantage of fixed exchange rate system has its limitation.

From JCB point of view floating exchange rate system is suitable backed by consistent government
economic policies.

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