Essay on Fixed Currency Exchange Rates: Government Administration and Global Currencies

The present regime in any country determines the fixed currency systems rate. The administration (government) puts and upholds the rate as the only certified exchange rate. The set rate is evaluated against the main currencies around the globe (Nicholas et al., 2012). Mostly this is done against the U.S. dollar. The central bank in local country purchases and trades local currency in the foreign exchange market in exchange for the U.S. dollar. This is done to sustain the local exchange rate. If, for instance, it is evaluated that the price of one local currency is equivalent to US $ 5, the central bank makes sure that it can provide the market with us US$ 5dollars. The central bank must, therefore, have much more U.S. dollars in their reserves so that they can maintain the rate. Having high amount of the US dollar in the reserves maintains the money supply as well as making sure that there are suitable fluctuations. Where appropriate, the central bank of any country using a fixed currency exchange system can adjust the official rate (Nazlioglu, 2013).

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The particular market rate determines the floating currency exchange system. This happens through the supply and demand cycle (Asteriou et al., 2016). The rate in this system is quite flexible since a change in the supply or demand, or both must be accounted for and auto-adjusted in the markets (Hall et al., 2010). One of the countries that use the floating currency system is USA. When the demand for the U.S. dollar is little the cost of the U.S dollar reduces. This translates to goods and services being cheap in USA while the imported ones being costly. This change results in the generation of more job vacancies, resulting in an auto-correction in the market. Unlike the fixed-rate system, the rate in the floating currency system keeps on shifting (Korkmaz et al., 2015).

When the system is fixed, the stress in the market may cause shift in the exchange rate. If the local currency mirrors, it real worth in comparison to the pegged currency, there is development of a black market (Baron, 1976). This market shows definite demand and supply in a particular country. The fixed system can lead to financial disaster, as was experienced in Russia (1997). This can occur if the local government endeavors to have high value of local currency against the pegged rate. This means that the regime in the country cannot meet the demand to change the pegged currency into the foreign money at the rate which it was pegged.

The investors in such a scenario rush for their investment, changing them into foreign currencies ahead of the devaluation of the money (Papaioannou, 2006). This results in diminishes the reserves for foreign currency. Financial disaster, as such, forced the Mexican government to devalue its currency by 30% (Tatliyer and Yigit, 2016). The floating rate system is very unique in this sense. This is because it dictates the interest rates in the country hence taking charge of controlling the economic growth in the country that has pegged its currency (Chiao and Hung, 2000).

The fixed system, the regime of the day, sustains the rates that do not change with shift in economic state (Bahmani-Oskooee and Ltaifa, 1992). The growth of economy in such countries is so sluggish since the rates are not changed with change in economic conditions. Besides, the interest in this system depends on the exchange rate. This can halt economic growth in the situation where the rate and the market need have discrepancy (Ito et al., 2016). When local currency is pegged to another currency, the economic state of such a country depends on the economic atmosphere of the international country. For example, the Egyptian pound is pegged on the U.S dollar. This means that the economic growth in Egypt is directly influenced by the economic conditions in USA. This makes USA dictate Egypt in an attempt to improve its economy. This means that the economy of Egypt will remain weaker than that of USA. Additionally, instability in the U.S. economy would greatly subvert the economy of Egypt (Cushman, 1983).

It is believed that the floating rate system results in a destabilized market and does not lead to development. The fluctuating exchange rates have been reported to cause economic crisis. The end of Bretton-woods system resulted in floating exchange rate system, which indicated this; the economist started viewing this system from a different point of view (Fang et al., 2009). According to Fang et al. (2009), the exchange rate instability was a result of poor economic rules. Therefore the mechanism of the exchange did not influence instability of exchange rates. The effects of fluctuating exchange rate have been reported to be minute; for instance, in 1980 the German buying power moved from 20% above the buying power of USA to 25% below the buying power of USA (Du and Zhu, 2001). Economists expected this to destabilize the German economy. However, the cost of the commodities remained the same in the currency of the buying country even with the shift in the exchange rate. Akay et al. (2016) argued that there was an over-shooting. This meant that long-time existing economies could decrease inflation by depreciating their currency. However, depreciating currency causes fall in the interests. Depreciation of currency can cause an increase in the buying power if the money falls lower than the required (Nergiz and Magda, 2011). For instance; when the money provision increases by 5%, the local currency is to be reduced by 5% over duration of time On the other hand, for the economic activity to increase the currency can only be reduced by 15% to anticipate a 10% increase (over-shooting).

Another major difference is based on inflation. Pegging can be used to get much and to decrease inflation. This involves pegging rates with arbitrage of goods (Haddad et al., 2010). The market has a behavior of having stable costs of commodities sold. This aspect results in wholesale indexation of home costs assured on the exchange rates. Inflation reduces the value of the home currency, causing raising the cost of local products. Having a solution to fix the exchange rate is important since it helps to halt inflation. The over-dependence on pegged rate ensures the local country relies on the international country for economic stability. The fixed exchange rate has been utilized in countries such as Bolivia (Nergiz and Magda, 2011).

The application of this regime heavily crumbled, and in some countries inflation persevered. A fixed exchange rate resulted in constant cost of the products sold and inflated prices of the goods not sold. According to Cheung and Sengupta (2013), the prices gradually rose as the local currency fell. The dependence on money results in positive and negative effects in any nation. The application of the floating exchange rate the government of the day is allowed to initiate different currency rules. This condition is difficult in the fixed-rate system.

In the recent world, there are new economic factors that are replacing the old ones. Aspects such as new means of communication and improved oversee trade indicate the need for flexible economy. Therefore aspects such as the measure of pegging are continuously losing the ground. On the other hand, shift in the floating exchange rate regimes can be limited by poor management and weak economic guidelines. The economic agreements between countries in the case of floating rate make policies better since an economic crisis in one country results in world problems.

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