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6.2.3 Merits and Demerits of Flexible and Fixed Exchange Rate Systems The main feature of the fixed exchange rate system is that there must be credibility that the government will be able to maintain the exchange rate at the level specified. Often, if there is a deficit in the BoP, in a fixed exchange rate system, governments will have to intervene to take care of the gap by use of its official reserves. If people know that the amount of reserves is inadequate, they would begin to doubt the ability of the government to maintain the fixed rate. This may give rise to speculation of devaluation. When this belief translates into aggressive buying of one currency thereby forcing the government to devalue, it is said to constitute a speculative attack on a currency. Fixed exchange rates are prone to these kinds of attacks, as has been witnessed in the period before the collapse of the Bretton Woods System. The flexible exchange rate system gives the government more flexibility and they do not need to maintain large stocks of foreign exchange reserves. The major advantage of flexible exchange rates is that movements in the exchange rate automatically take care of the surpluses and deficits in the BoP. Also, countries gain independence in conducting their monetary policies, since they do not have to intervene to maintain exchange rate which are automatically taken care of by the market. 6.2.4 Managed Floating Without any formal international agreement, the world has moved on to what can bebestdescribedasamanaged floatingexchangeratesystem.Itisamixtureofa flexible exchange rate system (the float part) and a fixed rate system (the managed part).Underthissystem,alsocalleddirty floating,centralbanksintervenetobuy and sell foreign currencies in an attempt to moderate exchange rate movements whenever they feel that such actions are appropriate. Official reserve transactions 95 are, therefore, not equal to zero. M O a e t Open economy Balance of payments o E e o o n Current account deficit Official reserve transactions o o o Autonomous and accommodating Nominal and real exchange rate i y C transactions s e Purchasing power parity Flexible exchange rate K Depreciation Interest rate differential Fixed exchange rate Devaluation Managed floating Demand for domestic goods Marginal propensity to import Net exports Open economy multiplier Reprint 2026-27