By Neil Buckland
By Neil Buckland
From purchasing currency for international travel and buying overseas goods to trading currencies through the foreign exchange, exchange rates can directly influence how much we spend in certain circumstances.
They can fluctuate wildly, while in the case of flexible exchange rates countries adopt a monetary system that determines base rates according to supply and demand. This brings both advantages and disadvantages, including the following:
Flexible Exchange Rate Help to Stabilise the Economy
In many ways, flexible exchange rates acts as automatic stabilisers in any domestic economy. More specifically, these rates can be adapted to suit the wider, macroeconomic climate, to compensate for disproportionate changes in inflation and economic output.
This enables central banks to leverage exchange rates as part of their monetary policy, particularly in instances when they are looking to stimulate growth.
There are instances where this can be counterproductive, however, and actually considered as a distinct disadvantage. In a volatile economic climate where countries have large surpluses or deficits, for example, flexible exchange rates can cause huge volatility and actively destabilize the global markets.
Flexible Exchange Rates Trigger Considerable Levels of Volatility
The issue of volatility in the financial marketplace is an interesting concept, and it can be considered as an advantage or a disadvantage depending on your outlook.
In general terms, flexible exchange rates lend themselves to high levels of volatility, as the shifts in the base rate are far more frequent and significant that the underlying fundamentals may imply.
From the perspective of forex trading experts, however, volatility can be leveraged to secure a competitive advantage. This is because the currency is considered to be a derivative asset class, and one that can enable traders to hedge against specific pairings and profit even in a depreciating market.
Flexible Exchange Rates can Underpin Autonomous Monetary Policies
We’ve already said that flexible exchange rates allow for more agile and effective monetary policies, but they also enable banks to introduce autonomous strategies.
These policies can subsequently be deployed to address problems relating to inflation and output, while forming the basis of quantitative easing programs during times of austerity or recovery.
In the case of trade, countries can use flexible rates to counter rising inflation without impact on their partners. Similarly, they don’t have to import their trade partners’ inflation rate, which is the case when using a fixed exchange rate.
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