Note on Exchange Rate Regimes

This note describes different exchange rate regimes that are currently used in the world economy. It also discusses the advantages and disadvantages of fixed versus floating exchange rate regimes. Excerpt UVA-BP-0456 NOTE ON EXCHANGE RATE REGIMES The theories of exchange rate determination that you have studied before assumed that exchange rates are primarily determined by market forces of supply and demand. In reality, however, countries have the choice between various exchange rate regimes within the context of the international monetary system. Some countries choose to let their currencies float freely against other currencies, and to allow the value of their currencies to be determined by the market. Other countries limit the flexibility of their exchange rates. As of May 2001, only 47 out of 184 countries had independently floating exchange rate arrangements (see Exhibit 1). The objective of this note is to describe different types of exchange rate regimes and the advantages and disadvantages associated with each one. Exchange Rate Regimes Countries have the choice of several exchange rate regimes or combinations of regimes, which include, in order of diminishing flexibility: 1. Flexible Exchange Rates: Flexible exchange rates fluctuate constantly in response to market forces. . . .