Exchange rate systems can be compared in a few different aspects:
- Certainty for Consumers
- Role of Foreign Reserve
- Impact on inflation
- Flexibility for policy-makers
- Effects on Speculation
- Correction of Current Account Imbalances
Certainty for Consumers
- Fixed:
- Under a fixed exchange rate system, consumers have greater certainty that the exchange rate will remain stable.
- This stability allows them to make long-term plans with more predictable outcomes.
- Floating: Under floating exchange rates, consumers face low certainty, as market forces can cause large fluctuations in currency values, making it difficult to plan investments and business activities.
- When the Hong Kong dollar is kept in a fixed exchange rate system pegged to the US dollar, consumers and businesses in Hong Kong have certainty about exchange rates.
- This stability allows households to plan long-term mortgages and companies to sign international contracts without worrying about sudden currency fluctuations.
- In contrast, during the sharp depreciation of the British pound after the 2016 Brexit referendum, UK consumers faced uncertainty as the falling pound raised the price of imports like food, fuel, and holidays abroad, making long-term financial planning more difficult.
Role of Foreign Reserve
- Fixed:
- To keep the exchange rate fixed at a certain level, central banks must frequently intervene by using foreign reserves.
- However, these reserves are limited and cannot sustain such a system over the long term.
- Floating: In this system, foreign reserves do not play a role, as central banks do not need to use them to maintain the exchange rate at the desired level.
