Merits of Fixed Exchange Rate System –
(a) Fixed exchange rate prevents the member countries from the economic fluctuation which can weaken the economic policies.
(b) It promotes capital movements. Fixed exchange rate system attracts foreign capital because a stable currency does not involve any uncertainties about exchange rate that may cause capital loss.
Demerits of Fixed Exchange Rate System -
(a) It creates a barrier on achieving the objective of free markets.
(b) Under this system, countries with deficits in balance of payment uses their stock of gold and foreign currencies to solve the problem. This can further create serious problem for them. They may be forced to devalue their currency. On the other hand, countries with surplus in balance of payments will face the problem of inflation.
Merits of Flexible Exchange Rate System
(a) It eliminates the problem of overvaluation or undervaluation of currencies, Deficit or surplus in balance of payments is automatically corrected under this system.
(b) It frees the government from problem of balance of payments.
Demerits of Flexible Exchange Rate System
The main demerits of flexible exchange rate are as follows :
(a) It creates situations of instability and uncertainty. Wide fluctuations in exchange rate are possible. This hampers foreign trade and capital movements between countries.
(b) The uncertainty caused by currency fluctuations can discourage international trade and investments.
