Fixed Versus Floating Exchange rate Systems (DP IB Economics)
Revision Note
Comparing Fixed & Floating Exchange Rate Systems
Many countries have attempted to use fixed exchange rate systems at some point in their history
Changes to the global or national equilibrium may cause Central Banks to consider which system may be most beneficial to achieving their macroeconomic goals at a specific point in time
A fixed exchange rate system offers stability, reduces speculative activities, but limits monetary policy autonomy
A floating exchange rate system allows for flexibility in monetary policy, automatic adjustments to economic conditions, but introduces greater exchange rate volatility
The choice between the two systems depends on a country's macroeconomic goals, stability objectives, and the external economic environment
A Comparison of a Fixed and Floating Exchange Rate System
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Changing from one System to the Other
Central Banks have to consider the impact of changing from one exchange rate system to another
Within a few minutes of removing the PEG, €1 = 0.90 CHF - the Swiss Franc had appreciated
(Source: FT.Com)
In January 2015 the Swiss Central Bank removed the fixed exchange rate (peg) of €1 = 1.2 CHF and allowed the currency to float freely
They did this because:
In the face of ongoing significant demand for their own currency, the Central Bank was using enormous reserves to supply more CHF to the market in order to maintain the peg
They could no longer afford to supply their own currency
The demand for their currency was partly driven by deteriorating conditions in Russia as Russia had taken over the Crimea, which caused investors to seek safe haven for their money in Switzerland
The Implications of Changing from one System to Another - Real World Example
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Currency Appreciation |
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Export Challenges |
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Impact on Tourism |
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Financial Market Turmoil |
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Deflationary Pressure |
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Monetary Policy Challenges |
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Global Implications |
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