Merit of Fixed Exchange Rate: Ensures Stability of the Fixed Exchange Rate

Fixed exchange rate is a system where the value of a currency is fixed to a specific commodity or to another currency. In this system, the government or the central bank of a country decides the exchange rate for its currency and maintains it by buying or selling foreign reserves. One of the merits of fixed exchange rate is that it ensures stability of the fixed exchange rate.

Explanation:

When a country fixes its exchange rate, it provides certainty to businesses and investors about the value of its currency. This certainty can encourage international trade and investment as businesses and investors can plan and budget with confidence. Also, it reduces the risk for currency fluctuations, which can impact the profitability of businesses and the purchasing power of consumers.

In a floating exchange rate system, the exchange rate is determined by the market forces of supply and demand. This can lead to volatility in the exchange rate, which can be detrimental to the economy. For example, if the exchange rate of a country’s currency suddenly drops, it can increase the cost of imports and cause inflation. This can cause uncertainty in the economy and reduce the confidence of investors and businesses.

On the other hand, in a fixed exchange rate system, the government or the central bank can adjust its monetary policy to maintain the exchange rate. This can help to stabilize the economy and maintain the confidence of investors and businesses. For example, if the economy is facing inflationary pressures, the government can raise interest rates to reduce the demand for money and stabilize the exchange rate.

In conclusion, the stability of the fixed exchange rate is a merit of fixed exchange rate system. It provides certainty to businesses and investors, reduces the risk of currency fluctuations, and helps to stabilize the economy.