Financial Sharing

Floating exchange rate and fixed exchange rate of foreign exchange

June 17, 2020

Floating exchange rate system means that the Central Bank of one country does not stipulate the official exchange rate between its own currency and that of other countries, and allows the exchange rate to be determined spontaneously by the foreign exchange market. When the supply of foreign currency exceeds the demand, the foreign currency depreciates, the local currency appreciates, and the foreign exchange rate falls. On the contrary, the foreign exchange rate rose. In order to maintain the stability and development of the national economy, the local currency authorities should intervene in the foreign exchange market properly to keep the exchange rate of the local currency from undulating too much.

The main advantages of floating exchange rate system are to prevent the impact of international hot money, to avoid currency crisis; to promote the growth of international trade and the development of production; to promote the flow of capital and so on. The disadvantages are that it often leads to fluctuations in the foreign exchange market, which is not conducive to the long-term international trade and investment; it is not conducive to the stability of the financial market; it is difficult for IMF to effectively supervise the exchange rate, and the balance of payments imbalance still cannot be solved; it is even more detrimental to developing countries.

Fixed exchange rate refers to the exchange rate with basically fixed exchange rate between one country’s currency and another country’s currency. From the beginning of the 19th century to the 1930s, during the gold standard period, after the Second World War to the beginning of the 1970s, the international monetary system centered on the US dollar, all carried out the fixed exchange rate system.

Fixed exchange rate does not mean that the exchange rate is completely fixed, but fluctuates around the upper and lower limits of a relatively fixed parity. For example, after the World War II, the fixed exchange rate system centered on the US dollar, the official price comparison between the currencies of the member countries of the International Monetary Fund against the US dollar is the parity, and the currency exchange rate of each member country can only fluctuate 1% above and below the parity, which is intervened by the central bank.

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