Debate the relative merits of fixed and floating exchange rate regimes. From the perspective of an international business, what are the most important criteria for choosing between the systems?
Debate the relative merits of fixed and floating exchange rate regimes. From the perspective of an international business, what are the most important criteria for choosing between the systems? Which system is the more desirable for an international business?
The case for fixed exchange rates rests on argument about monetary discipline, speculation, uncertainly, and the lack of connection between the trade balance and exchange rates. In terms of monetary discipline, the need to maintain fixed exchange rate parity ensures that governments don not expand their money supplies at inflationary rates. In terms of speculation, a fixed exchange rate regime precludes the possibility of speculation. In terms of uncertainty, a fixed rate regime introduces a degree of certainty in the international monetary system by reducing volatility in exchange rates. Finally, in terms of trade balance adjustments, critics question the closeness of the link between the exchange rate and the trade balance. The case for floating exchange rates has two main elements: monetary policy autonomy and automatic trade balance adjustment. In terms of the former, it is argued that a floating exchange rate regime gives countries monetary policy autonomy. Under a fixed rate system, a country’s ability to expand or contract its monetary supply as it sees fit is limited by the need to maintain exchange rat parity. In terms of the later, under the Bretton Woods system, if a country developed a permanent deficit in its balance of trade that could not be corrected by domestic policy, the IMF would agree to a currency devaluation. Critics of this system argue that the adjustment mechanism works much more smoothly under a floating exchange rate regime. They argue that if a country is running a trade deficit, the imbalance between the supply and demand of that country’s currency in the foreign exchange markets will lead to depreciation in its exchange rate. An exchange rate depreciation should correct the trade deficit by making the country’s exports cheaper and its imports expensive. It is a matter of personal opinion in regard to which system is better for an international business. We do know, however, that a fixed exchange rate regime modeled along the lines of the Bretton Woods system will to work. Nevertheless, a different kind of fixed exchange rate system might be more enduring and might foster the kind of stability that would facilitate more rapid growth in international trade and investment.
