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Question
What are fixed and flexible exchange rates?
Solution
A fixed exchange rate is fixed by the government or Central Bank of a country and the changes can be made by the government. Under this system, the value of a currency is fixed against different currencies to ensure stability in the exchange rate and it promotes foreign trade.
A flexible exchange rate is determined by demand and supply forces of varied currencies in the foreign exchange market. It is also called free rate of exchange, as it is freely determined by demand and supply forces in the international market. Here, the government does not hold any reserves and there is no problem of under or overvaluation of currency.
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