Under a fixed exchange rate system, governments try to maintain a constant value for their currencies against other currencies. A country's central bank commits to buying and selling its currency at a fixed price in order to maintain this exchange rate. Fixed exchange rates provide stability for international trade and control of inflation. Governments intervene in currency markets by buying and selling their own currency to influence supply and demand and maintain the fixed exchange rate when market forces would otherwise cause the rate to change.

1. The Fixed Exchange Rate System

2. fixed exchange rate
system
This system is a currency system in which governments
try to maintain their currency value constant against one
another.

3. In a fixed exchange-rate system, a
country’s government decides the worth
of its currency in terms of either a fixed
weight of gold, a fixed amount of another
currency or a basket of other currencies.
The central bank of a country remains
committed at all times to buy and sell its
currency at a fixed price. The central
bank provides foreign currency needed
to finance payments imbalances

5. WHY FIXED EXCHANGE RATE
SYSTEM?
 The fixed exchange rate is usually adopted with a
mind to have a stabilizing effect on the value of
domestic currency against foreign currencies.
 It simplifies issues of international trade between
two countries as expectations are more or less
defined
 It is also a tool for control of inflation.
 It also restricts governments from manipulating
domestic policy to serve the requirements for
economic stability on a macro level.

6. Usually a government achieves this by simply
trading its currency on the international market.
This explains the need for governments to keep
a stock of foreign currency. What usually takes
place here is a kind of speculation game by the
government. If the exchange rate drops, then
the government purchases its own currency and
uses it as a reserve. This creates a demand for
that particular currency and it increases the
price. If the exchange rates rise then the
government sells its currency which results in an
increase in its foreign reserves.
So how does a government maintain a fixed
exchange rate?

7. HOW DOES A GOVERNMENT MAINTAIN A FIXED
EXCHANGE RATE?
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Sc
Dc
E
Quantity of £
Quantity of $/£

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