Fixed Exchange Rate

• Government wanting to maintain fixed exchange rate

does to by either buying or selling it own currency on the
open market.
• Government, therefore, maintains the reserves of foreign
currencies.
• Maintaining fixed exchange rate means making it illegal
to trade currency at any other rate. This may lead black
marketing of currency trading (difficult to enforce the
policy).
• Some countries are highly successful in using this
method. Example : Chinese government.
Fixed Exchange Rate
Fixed exchange rate also has three different types.
• Fully fixed exchange rate :
 Government intervenes in the currency market in order to
keep the exchange rate close to the fixed target.
 It does not allow major fluctuation in this regime.
• Semi-fixed exchange rate :
 Exchange rate of currency can move within a permitted
range.
 The exchange rate is the dominant target of economic
policy-making.
 Interest rates are set to meet the targeted exchange rate.
 Fixed Exchange Rate
• Crawling Peg :
 It is an exchange rate regime usually seen as a part of fixed
exchange rate regime which allows depreciation or
appreciation in an exchange rate gradually.
 Central banks triggers a change when certain conditions are
met (like need for adjustment for inflation) to implement this
system.
Portugal followed this system until 1990.
 Some central banks prefer not to use a present formula and
change exchange rate frequently to discourage speculation.
 Due to high inflation Peso would need to be severely
devaluated. But, rapid devaluation would create instability.
 Mexico adopted Crawling peg system and Peso was slowly
devaluated toward a more appropriate exchange rate.
 Criticism of Fixed Exchange Rate

• Inflexibility of exchange rate to automatically adjust the balance

of trade.

• In fixed exchange rate system, government can not use monetary

or fiscal policy with a free hand.