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Differentiate between fixed and floating exchange rates.

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In a system of flexible exchange rates (also known as floating exchange rates), the exchange rate is determined by the forces of market demand and supply.

Countries have had flexible exchange rate system ever since the breakdown of the Bretton Woods system in the early 1970s. Prior to that, most countries had fixed or what is called pegged exchange rate system, in which the exchange rate is pegged at a particular level. Sometimes, a distinction is made between the fixed and pegged exchange rates.

Under a fixed exchange rate system, such as the gold standard, adjustment to BOP surpluses or deficits cannot be brought about through changes in the exchange rate.

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