Merits of Flexible Exchange Rate:
(i) Government intervention is reduced to the minimum. Bias of the Government or against exporter and importer will not be present. Usually Government fixes the value of currency which leaves the foreign currency undervalued.
This is done to keep the price of essential imported items as low as possible. Exporters are hurt in this process because they earn less rupee per dollar of export. This is in a way a hidden tax on exporters. Flexible exchange rate removes this bias.
(ii) Flexible exchange rate regime frees the Government from consideration about Balance of Payment and Government can concentrate on domestic economic policy.
Image Source: samiseconblog.files.wordpress.com
ADVERTISEMENTS:
(iii) Under fixed exchange rate, countries which are averse to inflation like Japan will be pitched against countries who view inflation with equanimity like USA. USA is more allergic to unemployment than inflation and usually keeps tow rate of unemployment and higher level of inflation than Japan. This creates conflict of interest among nations. Such conflicts are avoided in case of flexible exchange rate regime.
(iv) With flexible exchange rate, each country can choose whatever mixture of unemployment and inflation it prefers.
Demerits of Flexible Exchange Rate:
(i) Flexible exchange rate regime leads to uncertainty in the international trade. Exporters will not be able to plan their export revenue or import expenditure because of changing rate of exchange.
ADVERTISEMENTS:
(ii) Flexible exchange rate regime lead to problem of speculation. A country with continuous deficit has a tendency to devalue its currency. Speculators will demand foreign exchange by selling their domestic currencies. This will create excess demand for foreign currencies which may lead to black marketing and manipulation of prices of foreign currencies.
(iii) Flexible exchange rate regime has the danger of competitive depreciation of their currencies. All the countries want to increase their exports and decrease their imports in order to create favourable balance of payment position. This creates the danger of competitive depreciation leading to global depreciation.