Question

Advantages and disadvantages in the use of exchange list

Answer 1

Advantage of Floating Exchange Rates:

Floating exchange rates have the following advantages:

1. Automatic Stabilisation:

Any disequilibrium in the balance of pay­ments would be automatically corrected by a change in the exchange rate. For example, if a country suffers from a deficit in the balance of payments then, other things being equal, the country’s currency should depreciate.

This would make the country’s exports cheaper, thus increasing demand, while at the same time making imports expensive and decreasing demand. The balance of payments equilibrium would therefore be restored. On the contrary, a balance of payments surplus would be automatically eliminated through a change in the exchange rate.

2. Freeing Internal Policy:

Under the floating exchange rate system the balance of payments deficit of a country can be rectified by changing the external price of the currency. On the country if a fixed exchange rate policy is adopted, then reducing a deficit could involve a general deflationary policy for the whole economy, resulting in unpleasant consequences such as unemployment and idle capacity.

Thus, a floating exchange rate allows a government to pursue internal policy objectives such as full employment growth in the absence of demand-pull inflation without external con­straints (such as debt burden or shortage of foreign exchange).

3. Absence of Crisis:

The periods of fixed exchange rates were frequently characterised by crisis as too much pressure was put on central bank to devalue or revalue the country’s currency. However, the central bank that devalued a currency by giving out too much of it would soon either stop or run out of it.