Question
Explain two merits each of flexible foreign exchange rate and fixed foreign exchange rate.

Answer

Merits of fixed exchange rate:
  1. It ensures stability in exchange rate: The exporters and importers have not to operate under uncertainty about the exchange rate. Thus it promotes foreign trade.
  2. It promotes capital movements: Fixed exchange rate system attracts foreign capital because a stable currency does not involve any uncertainties about exchange rate that may cause capital loss.
Merits of flexible exchange rate system:
  1. It eliminates the problem of overvaluation or undervaluation of currencies, Deficit or surplus in balance of payments is automatically corrected under this system.
  2. It frees the government from problem of balance of payments, as it is taken care of by the forces of demand and supply.

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