Fixed and Flexible Exchange Rate
1 Quick Explanation 1–3 min
Fixed: the rate is officially set by the central bank; flexible: set by market demand & supply.
Each has its own merits and demerits — the classic comparison question.
2 Detailed Notes
Definition
Definitions
- Fixed exchange rate: the rate is determined (pegged) by the central bank / government at a certain level, maintained using reserves.
- Flexible (floating) exchange rate: the rate is determined purely by market demand for and supply of foreign exchange.
Key idea
How fixed rate is maintained
- If demand rises above the fixed rate's supply → central bank sells forex reserves to meet demand, keeping the rate pegged.
- If supply exceeds demand → central bank buys the surplus forex.
- Hence the rate stays fixed but reserves fluctuate.
Comparison
Merits & demerits
| Basis | Fixed | Flexible |
|---|---|---|
| Determination | Central bank / government | Market demand & supply |
| Stability | High (reduces uncertainty) | Can be volatile |
| Speculation | Encouraged (rate expected to change) | Less speculative attack on rates |
| Reserves | Required (to intervene) | Not needed |
| Automatic correction | No (intervention needed) | Yes (market adjusts) |
Important
Exam tip
Memory hook: 'Fixed = certainty but costly reserves; Flexible = automatic but uncertain.' Compare on stability, reserves, speculation, autonomy.
In One Minute
Fixed: official, stable, needs reserves to maintain. Flexible: market-driven, automatic adjustment, can be volatile. Comparing them is a guaranteed question.
Important for Exam
- ⭐ 3-marks: merits & demerits of fixed rate.
- ⭐ 3-marks: merits & demerits of flexible rate.
- ⭐ 6-marks: full comparison.
- ⭐ Why fixed rates need forex reserves.
Watch & Learn
Watch on YouTubeForeign exchange rate part 1 - Fixed exchange rate & Flexible exchange rate. Class 12 Indian eco
by Sunil Panda-The Educator
Why watch? Complete comparison with merits/demerits.
Open on YouTube Watch on YouTubeForeign exchange rate part 1 - Fixed exchange rate & Flexible exchange rate. Class 12 Indian eco
by Sunil Panda-The Educator
Why watch? Simple comparison tables.
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