Exchange Rate Regime

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EXCHANGE RATE REGIMES
The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market. In other words, the exchange rate regime tells us how exchange rate is determined in one country. In theory, there are three basic types of exchange rate regimes: a fixed exchange rate, which ties the currency to another currency, mostly more widespread currencies such as the U.S. dollar or the euro, a floating exchange rate, where the market dictates the movements of the exchange rate, and a pegged float, where the central bank keeps the rate from deviating too far from a target band or value. In this essay, we will discuss more deeply about each type of exchange rate regime and also point out their advantages and disadvantages.
Firstly, about fixed exchange rate. A fixed rate is a type of exchange rate regime in which the government (central bank) sets and maintains as the official exchange rate used to stabilize the value of a currency against the currency it is tied to. To fix the rate, typically, a government maintaining a fixed exchange rate by either buying or selling its own currency in the market. This is one reason governments maintain reserves of foreign currencies. For instance, if the equilibrium exchange rate drifts too far above the desired rate, the government sells foreign currency, thus decreasing its foreign reserves.
Fixed rate has some advantages. First, it reduces risks related to fluctuation in rate. By maintaining a fixed rate, before contracts are signed, buyers and sellers can agree a price and not be subject to the risk of later changes in the exchange rate. The greater certainty should help encourage investment. Then, fixed rates can also eliminate destabilizing speculation - speculation flows can be very destabilizing for an economy and the incentive to speculate is very small when…...

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