Differences between Flexible and Fixed Exchange Rates - Essay Example

In flexible exchange rate administration, the government upholds direct command of its money supply and loses control over the exchange rate. However, the opposite happens in a fixed-rate regime.

Furthermore, in a fixed exchange rate, the price of one currency is permanent compared to all other currencies by state authority. However, in a flexible or floating exchange rate system, the value of a currency is permitted to vary in reaction to the forces in the market. Alternatively, under the fixed exchange rates, the expansion of money reduces interest rates thus leading to outflows of capital. The eventual loss in coffers lowers the money supply (Jones & Lumby, 2003).

On the flip side, under the flexible regime, the exchange rate is depreciated by the capital outflow resulting in a stimulated output (Mukherjee, 2007). Finally, under the fixed exchange rate, positive demand increases interest rates and provokes an inflow of capital that balances the loss of the coffers through a deficit of trade. In contrast, under the floating rates, the inflow of capital appraises the exchange rates. Read More