Advantages of Flexible Rate:
1. It is claimed that in the case of flexible rate of exchange, the authorities are not obliged to locate and enforce any “appropriate” or “optimum” rate. It is left to the market forces to do this. The role of the authorities is only to be ready to intervene and prevent undue and violent fluctuations in it.
2. It is also claimed that when there is a structural incompatibility between the economies of the trading partners, a part of adjustment is affected through a change in exchange rate. This means that domestic market adjustment are kept to the minimum necessary.
3. A flexible rate of exchange provides a greater scope in the formulation of fiscal and monetary policies by the authorities.
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Disadvantages of Flexible Rate:
As against the above, critics of flexible rate of exchange put forth some strong arguments including the following:
1. It is claimed that flexible rate cannot ensure economic stability, either at full employment or below it. This argument, however, does not imply that fixed rate is preferable to the flexible one because in the case of the former, the entire adjustment takes place through change in money supply in the domestic economy.
2. Just as a fixed exchange rate cannot protect an economy from disruptive economic policies, similarly, a flexible exchange rate is also ineffective in this case. Rather, there is a greater suffering for the domestic economy if the rate of exchange is flexible due to uncertainties faced by importers and exporters.
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3. Critics of flexible rate say that it encourages speculative short term international flows of capital but discourage the flows of long-term investment capital. The latter needs a degree of certainty over a long period of time which flexible rate cannot provide. For this reason, flexible rate is not suitable for developing countries, which want to get direct investment, long-term loans and technology from abroad.
As a via media, some thinkers suggest that a country should preferably pursue a policy of “crawling peg” (or “moving peg”) backed by adequate intervention so that it does not experience undue and violent fluctuations. A crawling peg would ensure that the rate responds to underlying market forces but does not trigger speculative flow of capital or other destabilizing forces.