Types of fixed exchange rate systems Fixed exchange-rate system

1 types of fixed exchange rate systems

1.1 gold standard
1.2 price specie flow mechanism
1.3 reserve currency standard
1.4 gold exchange standard

types of fixed exchange rate systems
the gold standard

under gold standard, country’s government declares exchange currency weight in gold. in pure gold standard, country’s government declares freely exchange currency actual gold @ designated exchange rate. rule of exchange” allows go central bank , exchange coins or currency pure gold or vice versa. gold standard works on assumption there no restrictions on capital movements or export of gold private citizens across countries.

because central bank must prepared give out gold in exchange coin , currency upon demand, must maintain gold reserves. thus, system ensures exchange rate between currencies remains fixed. example, under standard, £1 gold coin in united kingdom contained 113.0016 grains of pure gold, while $1 gold coin in united states contained 23.22 grains. mint parity or exchange rate thus: r = $/£ = 113.0016/23.22 = 4.87. main argument in favor of gold standard ties world price level world supply of gold, preventing inflation unless there gold discovery (a gold rush, example).

price specie flow mechanism

the automatic adjustment mechanism under gold standard price specie flow mechanism, operates correct balance of payments disequilibrium , adjust shocks or changes. mechanism introduced richard cantillon , later discussed david hume in 1752 refute mercantilist doctrines , emphasize nations not continuously accumulate gold exporting more imports.

the assumptions of mechanism are:

adjustment under gold standard involves flow of gold between countries resulting in equalization of prices satisfying purchasing power parity, and/or equalization of rates of return on assets satisfying interest rate parity @ current fixed exchange rate. under gold standard, each country s money supply consisted of either gold or paper currency backed gold. money supply hence fall in deficit nation , rise in surplus nation. consequently, internal prices fall in deficit nation , rise in surplus nation, making exports of deficit nation more competitive of surplus nations. deficit nation s exports encouraged , imports discouraged till deficit in balance of payments eliminated.

in brief:

deficit nation: lower money supply → lower internal prices → more exports, less imports → elimination of deficit

surplus nation: higher money supply → higher internal prices → less exports, more imports → elimination of surplus

reserve currency standard

in reserve currency system, currency of country performs functions gold has in gold standard. country fixes own currency value unit of country’s currency, currency prominently used in international transactions or currency of major trading partner. example, suppose india decided fix currency dollar @ exchange rate e₹/$ = 45.0. maintain fixed exchange rate, reserve bank of india need hold dollars on reserve , stand ready exchange rupees dollars (or dollars rupees) on demand @ specified exchange rate. in gold standard central bank held gold exchange own currency, reserve currency standard must hold stock of reserve currency.

currency board arrangements widespread means of fixed exchange rates. under this, nation rigidly pegs currency foreign currency, special drawing rights (sdr) or basket of currencies. central bank s role in country s monetary policy therefore minimal money supply equal foreign reserves. currency boards considered hard pegs allow central banks cope shocks money demand.

without running out of reserves (11).. cbas have been operational in many nations like

hong kong (since 1983);
argentina (1991 2001);
estonia (1992 2010);
lithuania (1994 2014);
bosnia , herzegovina (since 1997);
bulgaria (since 1997);
bermuda (since 1972);
denmark (since 1945);
brunei (since 1967)

gold exchange standard

the fixed exchange rate system set after world war ii gold-exchange standard, system prevailed between 1920 , 1930s. gold exchange standard mixture of reserve currency standard , gold standard. characteristics follows:

all non-reserve countries agree fix exchange rates chosen reserve @ announced rate , hold stock of reserve currency assets.
the reserve currency country fixes currency value fixed weight in gold , agrees exchange on demand own currency gold other central banks within system, upon demand.

unlike gold standard, central bank of reserve country not exchange gold currency general public, other central banks.