fixed exchange rate system

fixed exchange rate system

a mechanism for synchronizing and coordinating the EXCHANGE RATES of participating countries which involves each country setting a fixed par value for its currency against other countries' currencies; for example, 1 US dollar = 260 Japanese yen. Once an exchange rate value is fixed, countries are expected to maintain this rate for fairly lengthy periods of time, but may choose to devalue their currency (repeg the exchange rate at a new lower rate – see DEVALUATION) or revalue it (repeg the exchange rate at a new higher value – see REVALUATION, definition 2) if their BALANCE OF PAYMENTS is, respectively in chronic deficit or surplus. Fixed exchange rates are maintained by the country's CENTRAL BANK intervening in the FOREIGN EXCHANGE MARKETS on a day-to-day basis, using its foreign exchange equalization account to buy and sell currencies as appropriate to stabilize the rate around its central par value.

The INTERNATIONAL MONETARY FUND formerly operated a system of fixed exchange rates, as did most members of the European Union under the fixed exchange rate requirements of the EUROPEAN MONETARY SYSTEM. Generally speaking, the business and financial community prefer a relatively fixed exchange rate to FLOATING EXCHANGE RATES, since it enables them to conclude trade and financial transactions at known foreign exchange prices so that the profit and loss implications of these deals can be calculated in advance. The disadvantage with such a system is that governments often tend to delay altering the exchange rate, either because of political factors or because they may choose to deal with balance of payments difficulties by using other measures, so that the pegged rate gets seriously out of line with underlying market tendencies. In consequence, for example, a firm's exports may become progressively less price-competitive in foreign markets because the country's currency is ‘overvalued’. See ECONOMIC POLICY.

Full browser ?