Floating and Fixed Systems

• exchange rate system today consists of two main types of foreign exchange management:

  1. floating system
  2. fixed system
• Fixed Exchange Rate System is similar to Bretton Woods Agreement
• Fixed Exchange Rate System is sometimes called a pegged exchange rate system
• many developing economies and emerging markets use fixed system tooday
• in the Fixed Exchange Rate System, the value of a currency is set relative to the value of another at a specified rate
• China pegs its currency to the value of a basket of currencies
• Belize pegs its currency to the US dollar
• a fixed regime promotes greater stability and predictability
• dirty float: countries try to hold the value of their currency within some range against the US dollar
• advanced economies use the Floating Exchange Rate System
• in the Floating Exchange Rate System, currency values are determined by market forces
• if a country is running a trade deficit, the floating rate system allows it to be corrected more naturally than a fixed exchange rate system