What is Fixed Exchange Rate? Complete guide !

What is fixed exchange rate ? 

A fixed exchange rate is basically a regime applied by an international government or central bank, which ties the domestic currency price of the nation with that of another foreign country or the price of precious metals. 

The point of a fixed exchange rate mechanism is to maintain the relative value of a particular currency against another. It is normally used as a method for stabilizing the foreign exchange rates. 

Fixed exchange rate







A floating exchange rate is basically one in which the value of the currency of one nation is allowed to vary according to the value of that nation's currencies against other nations.


Fixed exchange rate main purpose 

It is important to note that a fixed exchange rate serves entirely different purposes than a floating rate in monetary policy. 

A fixed exchange rate basically determines how the money of one nation can be purchased and sold by another nation at the same time and at equal prices. 

For instance, if a nation has a favorable exchange rate then the purchase of its currency by another nation will be relatively cheaper than the purchasing of the currency of the other nation. 

Thus a fixed exchange rate influences the foreign trade (though not as significantly as a floating-rate) and the level of international investmen

fixed exchange rate system has several different names

A fixed exchange rate system has several different names including the base rate, the fixing rate or the international rate and the exchange link rate. In a fixed exchange rate, the central bank controls the rate by fixing it above a particular market rate. 

This tends to ensure that the central bank is able to control the inflation of the domestic currency and so it acts to stabilize the domestic rate. 

The central bank may also intervene to stop excessive trading of the national currency or to stabilize an economy. If it is decided by the central bank to intervene in the economy, then the intervention will be through either open or closed-rate mechanism. 

For instance, a low domestic rate could be brought about by opening up the rate at zer

Fixed exchange rates between nations

Fixed exchange rates between nations are important for international trade. Most of the major international financial flows are determined by exchange rates between countries. 

There are various different ways of measuring the value of the currencies of different countries. A major component of these is the GFL, which is the weighted float premium on the currencies of each natio


Government intervene in foreign exchange 

In the past, most governments have tried to intervene in the foreign exchange market to prevent large-scale shocks to their own economies. 

For example, some of these interventions have been successful in reducing negative shocks to GDP growth. However, with the recent global financial crisis, these interventions have been less successful, with the exception of the Swiss National Ban

important part of the foreign exchange market 

Another important part of the foreign exchange market is the foreign exchange reserve. The central banks attempt to balance the amount of currency reserves held against the total demand for those reserves. 

If the exchange rate is unstable, the central banks are forced to loosen the rate they hold in order to counteract the negative impact on the economy of a floating exchange rate. 

The central banks can also use these moves to control the level of interest rates by changing the composition of their portfolios of liabilities. On the other hand, if there is a surplus in the economy, these moves can lead to significant inflationary pressure

main source of information

The main source of information on changes in floating exchange rates is the currency board. The currency board is divided into two sections, the base and the market. 

The base section shows the quotations from across the world, whilst the market section provides data on the movements in foreign exchange rates against the base currency. Data on the balance of payments between the major world currencies is also published on the currency boar

main purpose of maintaining reserves of currencies

The main purpose of maintaining reserves of currencies is to counter adverse fluctuations that may occur in the open market. 

For this reason, most of the time, it is decided that a set amount of foreign currency will be held as reserve, with a specific date chosen to when the reserves will be pulled out of the market. 

The date chosen to pull out the reserves normally varies by the type of currency being traded. In cases of fixed exchange rate fluctuations, usually the date chosen for pulling out the reserves is the open market day. 

In a floating rate, the date chosen for pulling out the currency reserves is pre-determined. The maintenance of currency balances is seen as important for maintaining both competitiveness and inflationary pressures.d.s.k.n.o.t.

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