Merits of Fixed Exchange Rate System

Some of the major advantages of a fixed exchange rate system are as follows:

1. Eliminate Uncertainty and Risk: In order to have orderly and steady growth in trade, it is essential to have stability in the exchange rate. If there is any change in the exchange rate it can cause problems to the plans of importers and exporters. Any fluctuation in the exchange rate may result in uncertain income for the exporters and cost for the importers. This kind of uncertainty is removed through a fixed exchange rate system.

2. Discourage Speculation: As the exchange rate under this system remains constant for quite a long time, people expect the rate to not change in the immediate future, which eliminates any kind of speculation in the foreign exchange market. Besides, it also discourages capital flight. If there are more fluctuations in the exchange rate, it increases the risk of capital flight as it encourages people to speculate. However, as the exchange rate is fixed in this exchange rate system, the traders feel confident about their international payments.

3. Attracts Foreign Investment: If a country has a fixed exchange rate system, it may encourage foreigners to invest their money in that country. These foreign investments with multiplier effects result in the high economic growth of the country.

4. Anti-inflationary: The fixed exchange rate system is anti-inflationary in nature. It means that, if the exchange rate is allowed to fall, then the import goods tend to become dearer to people. Also, the high cost import goods results in inflation. Such situations are prevented by a fixed exchange rate system.

5. Prevents Depreciation of Currency: Poor developing countries usually face permanent BOP difficulties, and under these situations, if the exchange rate also changes, it can provoke the BOP crisis, such as, the home currency may continue to depreciate in terms of the currencies of other countries. This is prevented by a fixed exchange rate system.

6. Adoption of Responsible Macroeconomics Policies: If the exchange rate system of a country is stable/fixed, it prevents the government from adopting any kind of irresponsible macroeconomic policies such as currency devaluation, etc. Besides, with the help of a fixed exchange rate system, a country can pursue deflationary policies to tide over its BOP deficit without making any changes to its domestic policies.

A medium of exchange for goods and services is called currency, which is different from one country to another country. However, a country&#x2019s currency cannot be used in another country. For this purpose, the currency of one country is converted into the currency of another country, and the rate at which one currency is exchanged for another is called the Foreign Exchange Rate. Foreign exchange rates can be classified into various types. One of them is the Fixed Exchange Rate System. Fixed Exchange Rate System is determined by the government.