explain the merits and demerits of fixed rate exchange
Merits of fixed exchange rate system:
- Ensures assured returns and safety of funds invested: For an underdeveloped or developing country, fixed exchange provides assurance to the investors and encourage them make significant investments and that too for long term. This is because they know that there would not be much fluctuation in the exchange rate in future.
- Infuses confidence to importers & exporters: Another benefit of fixed exchange rate is that fixed exchange rate ensures certainty regarding the foreign payment and thereby, builds confidence among importers and exporters. This promotes international trade.
- Ensures economic stabilisation: Fixed rate exchange system also ensures internal economic stabilisation and checks unwarranted changes in price. So from this point of view it looks as fixed exchange rate leads to economic growth.
- Impotent monetary policy tools: If a country wishes to use monetary policy tools, then it cannot go with fixed exchange rate regime as monetary policy is totally ineffective under such a system.
- Maintenance of huge foreign exchange reserves: Another problem associated with fixed exchange rate is that the Central Bank has to maintain a large amount of foreign exchange reserves with it so as to stand ready to sell and purchase foreign exchange at any point of time so as to maintain the exchange rate fixed.