Main Types of Foreign Exchange Rates

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Some of the major types of foreign exchange rates are as follows: 1. Fixed Exchange Rate
System 2. Flexible Exchange Rate System 3. Managed Floating Rate System.

1. Fixed Exchange Rate System (or Pegged Exchange Rate System).

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2. Flexible Exchange Rate System (or Floating Exchange Rate System).

3. Managed Floating Rate System.

1. Fixed Exchange Rate System:

Fixed exchange rate system refers to a system in which exchange rate for a currency is fixed
by the government.

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1. The basic purpose of adopting this system is to ensure stability in foreign trade and capital
movements.

2. To achieve stability, government undertakes to buy foreign currency when the exchange
rate becomes weaker and sell foreign currency when the rate of exchange gets stronger.

3. For this, government has to maintain large reserves of foreign currencies to maintain the
exchange rate at the level fixed by it.

4. Under this system, each country keeps value of its currency fixed in terms of some
‘External Standard’.

5. This external standard can be gold, silver, other precious metal, another country’s
currency or even some internationally agreed unit of account.
6. When value of domestic currency is tied to the value of another currency, it is known as
‘Pegging’.

7. When value of a currency is fixed in terms of some other currency or in terms of gold, it is
known as ‘Parity value’ of currency.

For, “Merits and demerits of Fixed Exchange Rate System”, refer Power Booster.

Devaluation and Revaluation:

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Devaluation refers to reduction in the value of domestic currency by the government. On the
other hand, Revaluation refers to increase in the value of domestic currency by the
government.

Devaluation Vs. Depreciation:

Basis Devaluation Depreciation

Meaning: Devaluation refers Depreciation refers to fall

to reduction in price in market price of
of domestic currency domestic currency in
in terms of all terms of a foreign
foreign currencies currency under flexible
under fixed exchange rate regime.
exchange rate
regime.

Occurrence: It takes place due to It takes place due to

Government. market forces of demand
and supply.

Exchange Rate It takes place under It takes place under

System: fixed exchange rate flexible exchange rate
system. system.
2. Flexible Exchange Rate System:
Flexible exchange rate system refers to a system in which exchange rate is determined by
forces of demand and supply of different currencies in the foreign exchange market.

1. The value of currency is allowed to fluctuate freely according to changes in demand and
supply of foreign exchange.

2. There is no official (Government) intervention in the foreign exchange market.

3. Flexible exchange rate is also known as ‘Floating Exchange Rate’.

4. The exchange rate is determined by the market, i.e. through interactions of thousands of
banks, firms and other institutions seeking to buy and sell currency for purposes of making
transactions in foreign exchange.

For, “Merits and demerits of flexible exchange rate system”, refer Power Booster.

Fixed Exchange Rate System Vs Flexible Exchange Rate System:

Basis Fixed Exchange Flexible Exchange Rate

Rate

Determination of It is officially fixed It is determined by

Exchange Rate: in terms of gold or forces of demand and
any other currency supply of foreign
by government. exchange.

Government There is complete There is no government

Control: government intervention and it
control as only fluctuates freely
government has according to market
the power to conditions.
change it.

Stability in The exchange rate The exchange rate keeps

Exchange Rate: generally remains on changing.
stable and only a
small variation is
possible.

3. Managed Floating Rate System:

Traditionally, International monetary economists focused their attention on the framework
of either Fixed or a Flexible exchange rate system. With the end of Bretton Woods’s system,
many countries have adopted the method of Managed Floating Exchange Rates.

It refers to a system in which foreign exchange rate is determined by market forces and
central bank influences the exchange rate through intervention in the foreign exchange
market.

1. It is a hybrid of a fixed exchange rate and a flexible exchange rate system.

2. In this system, central bank intervenes in the foreign exchange market to restrict the
fluctuations in the exchange rate within certain limits. The aim is to keep exchange rate
close to desired target values.

3. For this, central bank maintains reserves of foreign exchange to ensure that the exchange
rate stays within the targeted value.

4. It is also known as ‘Dirty Floating’.

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