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What is the difference between floating currency and fixed currency?
Let us first see what floating currency is and fixed currency −
Floating currency
A floating currency is a monetary system that is not backed by gold or assets. Based on supply and market expectations value of the currency fluctuates. The value of a currency is determined by the level of foreign reserves and global demand.
If the currency has demand, then the value of currency appreciates and impacts country’s exports (lower the demand for exported goods). To attract consumers, an exporter has to low their prices which decreases their profits and faces risk of going out of business.
If the currency demand is low, then the value of currency depreciates and impacts country imports. This means importing goods from other countries will become expensive. Purchase for domestic goods will increase and stimulates domestic economy
Fixed currency
In this system, currency of one country is linked to currency of another country. It limits central bank ability in adjusting interest rates and affects country’s growth rate. It can be maintained if agrees countries ensures strict capital controls
It provides certainty to both importers and exporters. By connecting with super power countries and small countries can protect themselves from paying more amounts for their imports. This also ensures smooth flow money from country to other country.
Smaller countries or less developed countries can attract more foreign investment and also helps them to avoid devaluation of their domestic currency and inflation can be kept stable
The major differences between floating currency and fixed currency are as follows −
| Floating currency | Fixed currency |
|---|---|
| Reduces foreign currency reserves. | Inward investment. |
| Can set policy interest rates for domestic objectives. | Cost of currency hedging is reduced. |
| Imported inflation is prevented. | Control inflation (stability). |
| Act as insulation from external stocks. | Borrowing cost is low. |
| Current account deficit is partially corrected (automatically). | Responsibility on government policies. |
| Risk is less for speculations. | Speculation is less. |
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