What is the advantage and disadvantage of Fixed Rate?

Advantages of Fixed Rate:

1. Fixed exchange rate protects traders against a lot of uncertainty. Each trader knows what he is to receive or pay in terms of domestic currency. Therefore, fixed rate provides a firm a reliable basis for taking trade decisions. It helps in promotion of international trade.

2. On account of the element of uncertainty, the traders can operate within narrower margins of operating surplus. Volume and variety of trade increase on account of these reasons also.

3. Fixed exchange rate implies that any discrepancy between the structures of domestic and foreign economies has to be ironed out by suitable domestic policies. Consequently, the authorities generally practice greater self-discipline in their fiscal and monetary policies.

Disadvantages of Fixed Rate:

1. It is very difficult to determine an appropriate rate of exchange without trial and error. The selected rate may turn out to be such that it results in a persistent surplus or deficit balance of payments. It cannot be found out without taking into account the relevant elasticities of demand and supply. And during trial and error, by definition, the rate is not really a fixed one.

2. Even if we assume that a country is able to adopt an appropriate exchange rate, it needs a revision with the passage of time. There is nothing like a optimum rate for all times to come.

3. Maintaining a fixed exchange rate may necessitate a lot of additional restrictions on the domestic economy to keep international payments “in balance”.

4. The authorities may be forced to pursue an inflationary or deflationary policy within the country so as to counteract one-sided pressure on balance of payments. And this may have to be done even when these pressures originate in some foreign countries. In other words, cyclical fluctuations originating abroad get imported into the domestic economy when exchange rate is not revised and used to weaken or neutralize those fluctuations.