Describe in detail about Exchange rate systems
Various countries have different exchange rate systems. The most significant characteristic of an exchange rate system is to what degree country is trying to control exchange rate.
- A country may have a entirely flexible exchange rate. Exchange rate is then determined solely by demand and supply in a free market without intervention of government or central bank.
- A country may have an entirely fixed exchange rate by pegging exchange rate to another currency or to an average of several currencies. A country may, for instance, decide that one unit of its currency would be exchanged for exactly 0.2 euro. One euro would then cost 5 of the domestic currency.
- A country may also have an exchange rate system in between these two extremes, termed as a "managed float". In this system, central bank only intervenes under special circumstances when it wants to influence exchange rate one way or the other.
- A country may also be part of a monetary union where all countries in union share the same currency. There is then no exchange rate between these countries in union. The union should itself select an exchange rate system vis-à-vis other currencies. Largest monetary union is the EMU, European Monetary Union with its currency euro. Euro is flexible against other currencies (besides those which are pegged to the euro).