Introduction:

A fixed exchange rate (also known as a pegged exchange rate) is a system in which a country’s currency value is tied or pegged to another currency, a basket of currencies, or a commodity like gold. Under this system, the government or central bank commits to maintaining the currency’s value within a narrow band relative to the reference currency or commodity. The merits and demerits of fixed exchange rate.

Merits of fixed exchange rate:

1. It contains an element of certainty which helps exporters or importers in conducting the business and thus encourages development of international trade.
2. It ensure regular flow of foreign capital and support progressive planning efforts.
3. It is essential to have an orderly growth of world’s money and capital market and the regularized flow of international capital movement it facilitates long term international investment
4. It sets out regular speculative activities in foreign exchange
5. It gives an added incentive to the country to adjust its domestic affair in order to maintain a fixed exchange rate.
6. It is more advantage to follow a fixed exchange rate system than one with fluctuating rates in modern Times when the economic among the nation has traffic become to vast and complex
7. It is desirable; if multi lateral trade transaction and agreements are to be encouraged through regional economic cooperative of different countries.
8. It systematize the world monitory system, thus the IMF has adopted fixed or pegged exchange rate system.
9. stable exchange rate will also assist in material economic stabilization on the other hand freely fluctuating exchange rates encourages abnormally high liquidity preference which leads to hoarding higher rates of interest shrinking investment and increasing unemployment.

Demerits of Fixed Exchange Rate:

• In a fixed exchange rate system, the central bank must prioritize maintaining the exchange rate over other economic goals. This restricts its ability to use monetary policy tools, such as interest rates, to address domestic economic issues like inflation, unemployment, or economic recession.
• A country with a fixed exchange rate is more susceptible to external economic shocks. For example, if the country to which the currency is pegged experiences inflation or a financial crisis, the pegged country may also be affected, as it cannot easily adjust its exchange rate to mitigate the impact.
• Fixed exchange rate systems can become targets for speculative attacks. If investors believe that a currency is overvalued or undervalued, they may engage in massive buying or selling of the currency, forcing the central bank to use its reserves to defend the peg. If the reserves are insufficient, the country may be forced to devalue or abandon the fixed exchange rate.
• A fixed exchange rate can lead to persistent trade imbalances. If a country’s currency is pegged at a level that makes its exports too expensive or its imports too cheap, it may run chronic trade deficits, which can lead to a depletion of foreign reserves and financial instability.
• In a floating exchange rate system, currency values adjust naturally to correct trade imbalances. For example, a country with a trade deficit would typically see its currency depreciate, making its exports cheaper and imports more expensive. In a fixed exchange rate system, this automatic adjustment does not occur, potentially leading to prolonged economic imbalances.
• To maintain a fixed exchange rate, a country must hold substantial foreign exchange reserves to intervene in the currency market when necessary. Accumulating and maintaining these reserves can be costly, especially for developing countries with limited financial resources.
• A fixed exchange rate can lead to economic rigidity, as the country cannot easily respond to changing global economic conditions. This can make it difficult to adapt to new economic realities, such as shifts in global demand, changes in commodity prices, or new trade dynamics.

also read: explain the merits and demerits of MNCs.