Question

Question 2. Which currency regime is best and why?

Answer 1

we are considering the fixed and floating exchange rate regime:

The fixed exchange rate system: In the fixed exchange rate system, the value of a currency is tied to a value of a single currency, or a basket of currencies or it can also be tied to gold.

Floating exchange rate: in the floating exchange rate, the value of a currency is allowed to fluctuate freely according to the market forces, that is supply and demand. Due to this, the currencies become highly volatile and can create further issues for a country which is already experiencing unemployment and inflation .

The floating exchange rate, causes the exchange rates to fluctuate which increases volatility . This can be a concern for developing countries as they will have to pay for the liabilities, which are denominated in foreign currencies. On the brighter side, The floating exchange rates can easily adjust to trade imbalances.As the amount a domestic country pays in exchange of the goods of the foreign countries changes , it can help balance out deficits as the supply and demands for such currencies keeps on changing.

In case of the fixed exchange rate, the counties cannot use their monetary or fiscal policies freely. Fixed exchange rates do not adjust itself to trade imbalances. It helps keeps inflation low , due to the certainly factor it provides to the importers and exporters and they are sure of the price they are paying for in the exchange for currencies in the future. It helps promote international trade this helps keep the interest rates low for a country.

Many economists believe that the floating exchange rate is best as it can adjust itself to the fluctuations of the foreign exchange market. When a country adopts the floating exchange rate regime it can help dampen the effects of fluctuations in the business cycles. This system of exchange rates is simple and provides more freedom in creating monetary policies.