Introduction
Foreign exchange rate is a critical element that determines the conditions of a countrys foreign trade and affects the basic interest pattern of a nation. Exchange rate accounts for the purchasing power of a currency in different markets and determines the cost of goods and services exported and imported in an economy. To understand the exchange rate and its management, various exchange rate regimes have been set up. This paper will explore the current exchange rate regime and its role in economic stability, globalization, international trade and business investments.
Exchange Rate Regime
The exchange rate regime is the framework set up to manage the exchange rate of a countrys currency with respect to other currencies. Exchange rate regimes are categorised into fixed regime and floating regime. In a fixed regime, a national currency is fixed to one or more foreign currencies with the intervention of a national authority, often central bank. In a floating regime, the exchange rate moves based upon the market forces of demand and supply in the foreign exchange over time.
Currently, the majority of countries have floating exchange rate regimes. The floating exchange rate regime allows the markets to adjust freely with demand and supply which promotes capital flows, more investment opportunities and more international trade. This regime provides an adjustable exchange rate which in turn provides the economic stability against shock among different nations.
Effects on Stability
Exchange rate regimes effect the foreign trade and economic stability of a nation. A floating regime allows the exchange rate to move power supply and demand. On the other hand a fixed regime offers certainty of the exchange rate and economic stability which lasts until a shock to the global economy causes it to break. Hence both exchange rate regimes have their advantages and disadvantages which need to be well understood.
Currently, the majority of nations have floating exchange rate regimes. Floating exchange rate regimes are believed to be suitable for small economies as it provides an adjustable exchange rate in order to keep global market shocks in check. Furthermore, the floating exchange rate regime offers investors and traders with the opportunity to take advantage of divergence of interest rates across different countries. This helps in stabilising the foreign exchange market and also provides a good hedge against domestic currency changes.
Effects on Globalization
The exchange rate regime is one of the key components of globalisation which has immensely impacted the world of international business. Globalisation has positively impacted the international business investments, thereby creating more opportunities for businesses to operate in different nations. A floating exchange rate regime supports globalisation as investors and traders are able to make important decisions regarding investments and international trade in a flexible environment.
It has been argued that globalisation can only occur if nations are willing to implement and maintain the floating exchange rate regime. This is mainly because globalisation helps to increase economic links with other nations by reducing trade and transaction costs. In addition, the floating exchange rate regime supports foreign investments by offering profitable opportunities to the investors.
Effects on International Trade
The exchange rate regime also affects the international trade. A floating exchange rate regime promotes international trade through the adjustment of current exchange rates in response to changes in demand and supply. This reduces the risk of capital outflow which occurs in fixed exchange rate regimes when foreign investors withdraw their funds due to a decrease in external demand.
Furthermore, floating exchange rate regimes are believed to be more effective in regulating mechanisms of international trade as they provide better protection against exchange rate fluctuations. This prevents large losses due to depreciation of a foreign currency in comparison to the domestic currency. This is especially important when dealing with large scale export and import transactions.
Conclusion
In conclusion, the exchange rate regime is an important consideration when looking at economic stability, international trade, globalisation and investments. It is clear that the majority of nations have chosen to adopt a floating exchange rate regime. This regime offers the flexibility of adjusting exchange rates in order to counteract shocks to the economy. In addition it also promotes globalisation by reducing flow transaction costs and encouraging foreign investments. As such, the floating exchange rate regime is a necessary tool for continued stability and success in the areas of international trade and investment.
