Floating and Fixed Exchange Rates - Benefits and Costs

In these two short revision videos, we explore the relative advantages and drawbacks of floating and fixed exchange rates.

Floating Exchange Rates

A free-floating currency is where the external value of a currency depends wholly on market forces of supply and demand – there is no central bank intervention and the exchange rate is not a target of monetary policy.

For example, both UK sterling and the Euro are free-floating currencies. The UK has had a free-floating exchange rate since leaving the EU exchange rate mechanism in September 1992.

Fixed Exchange Rates

A fixed exchange rate system exists when there is a hard or semi-fixed currency peg. The central bank of the country must hold sufficient foreign exchange reserves in order to intervene in currency markets when required to maintain the fixed currency anchor. Trade in goods & services takes place at this official exchange rate although there might be unofficial trades in shadow (grey) currency markets.