Dilemma and paradox of fixed and floating exchange rate regime(International Business)

In the fixed exchange rate regime, the exchange rate between the home and trading countries’ currencies are kept constant, the rate is kept fixed by the regulatory for which they constantly buy or sell the foreign reserves to maintain that exchange rate.  Whereas in the context of the floating exchange rate regime, the exchange rate hovers as per the demand and supply of the currency in the forex market.  Principally, whenever the demand for the currency increases, the value of currency appreciates and when the supply increases in the forex, it depreciates.

And, as per my understanding, the exchange rate regime depends upon the state of the economy as well as the fiscal and monetary objective set by the country.  The bigger economies like the USA, the UK apt for floating exchange rate regime as it helps in automatic stabilization of the currency rate, for example, if there is a deficit(trade deficit) in the balance of payment, then it will depreciate the currency and make its export cheaper and import expensive, this will ultimately restore the balance of payment to the equilibrium and in the same way the government can control the monetary policy of the country, whereas, the rate changes daily in the floating regime which encourages speculation in the forex market. 

In regards, the fixed exchange creates financial stability in international trade and minimizes the speculations, but it compels the country to hold a huge volume of foreign currency to play when required to maintain the fixed rate. As stated by the term, “Trilemma”, also called an impossible trinity, a country cannot achieve the free flow of capital, a fixed exchange rate, and independent monetary policy simultaneously, at each time they have to choose two letting the third one go (Kenton, 2018).

My country has pegged its currency with the Indian currency at 1.6 Nepali currency = 1.0 Indian currency. Since 60% of our international trade occurs with India, pegging has helped us to nullify the currency speculation risk, my country is a net-importing country and we are already in billions of dollars trade deficit, if we had the floating rate regime and if our currency has depreciated against the Indian currency further, then the deficit would have skyrocketed. Except, Indian currency, we have a floating rate regime with other countries.  But as stated above in impossible trinity, we do not have hold in our monetary policy.  Similarly, the Chinese government has pegged its currency with the USA currency which has indeed supported the Chinese export by devaluating its currency against its USA dollar (Bovaird, 2018) but the American government is blaming China for devaluating its currency creating currency war between the countries.

Hence, the fixed and floating exchange rate regime have their own pro and cons. Depending on the economic, political, socio-cultural and trade status of the country, they choose the currency rate regime. The model that fits best for one economy may be impractical for another and we should also take care of the rule of impossible trinity.

Bibliography

Bovaird, C. (2018, October 19). Why Is the Chinese Yuan Pegged? Retrieved from www.investopedia.com: https://www.investopedia.com/articles/forex/030616/why-chinese-yuan-pegged.asp

Kenton, W. (2018, February 28). Trilemma. Retrieved from www.investopedia.com: https://www.investopedia.com/terms/t/trilemma.asp