counter-argument comparing Fixed Exchange Rate and Flexible Exchange Rate systems — analyzing each other's weaknesses and presenting arguments against them from the opposite perspective
20/June/2025 01:26
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Here is a counter-argument comparing Fixed Exchange Rate and Flexible Exchange Rate systems — analyzing each other's weaknesses and presenting arguments against them from the opposite perspective:
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Counter-Arguments on Fixed and Flexible Exchange Rates
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✅ Against Fixed Exchange Rate – In Favor of Flexible
1. Rigid and Artificial Control:
A fixed rate does not reflect the true market value of a currency. It often forces the government to artificially maintain a value that is out of sync with economic fundamentals.
2. Costly Maintenance:
To maintain a fixed rate, central banks must hold huge foreign exchange reserves and intervene frequently, which is economically burdensome, especially for developing countries.
3. No Automatic Correction:
In case of a trade deficit or surplus, the fixed system does not adjust automatically, leading to long-term imbalances and potential currency crises.
4. Limited Policy Flexibility:
Countries lose the ability to adjust monetary policies (like interest rates or money supply) freely, as all policies must support the fixed rate instead of domestic needs.
5. Prone to Currency Crises:
If the fixed rate is not credible, it can lead to speculative attacks and forced devaluations, as seen in the 1997 Asian Financial Crisis.
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✅ Against Flexible Exchange Rate – In Favor of Fixed
1. Volatility and Instability:
Exchange rates under a floating system fluctuate frequently, which increases uncertainty for international traders, investors, and governments.
2. Discourages International Trade and Investment:
Constant changes in exchange rates increase the risk of losses, discouraging long-term trade agreements and foreign investments.
3. Speculation and Manipulation:
Floating rates are often influenced by speculators and short-term capital flows, not by actual trade or production, leading to irrational price movements.
4. Imported Inflation Risk:
A depreciating currency can make imports more expensive, leading to higher inflation, especially in countries that rely on imported goods or raw materials.
5. Lack of Discipline:
Governments may misuse the flexibility of floating rates to cover economic mismanagement, leading to long-term instability and inflation.
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Conclusion of Counter-Arguments
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Balanced Approach:
Due to the weaknesses of both extremes, many countries like India adopt a managed floating exchange rate system, where the market determines the rate, but the central bank intervenes when necessary to avoid excessive volatility.
