Under Fixed Exchange Rate system, if the value of INR is pegged to USD in such a manner that $1 = 50 INR
Does it mean that :
(1) $1 will always be equal to 50 INR under all circumstances irrespective of market conditions and forces of supply and demand
OR
(2) The relative value of INR and USD can change due to market conditions and forces of supply and demand, but the Central Bank via selling and buying of foreign currency in the market will ensure that $1 = 50 INR
Which alternative is correct (1) or (2)????
If (2) is correct then what is the difference between Managed Floating System and Fixed Exchange Rate System???
Dear student,
Alternative (2) is correct. Under a fixed exchange rate system the exchange rate is fixed by the monetary authority and it strives to maintain the rate by sale and purchase of own currency/foreign currency.
On the other hand, under a managed floating exchange rate the exchange rate is allowed to fluctuate freely on the basis of the market forces of demand and supply but the government might intervene in order to avoid frequent and extreme fluctuations.
Alternative (2) is correct. Under a fixed exchange rate system the exchange rate is fixed by the monetary authority and it strives to maintain the rate by sale and purchase of own currency/foreign currency.
On the other hand, under a managed floating exchange rate the exchange rate is allowed to fluctuate freely on the basis of the market forces of demand and supply but the government might intervene in order to avoid frequent and extreme fluctuations.