Introduction
The international monetary system is a multi-faceted mechanism with many variables, which may alter the nature of business operations depending on their timeframe and location. The existing differences between exchange rates of various currencies contribute to the overall complexity of the environment, adding uncertainty and risks in some cases. The discussed issue has been an area of intense interest in the context of economic studies, and several related models have been proposed. Each of them demonstrates particular features, which can be interpreted as advantages or downsides depending on the context. The purpose of this essay is to review fixed and floating exchange rate models from the perspective of an international company.
The International Monetary System
Continuous globalization of economic affairs and closer relations between markets have conditioned the demand for a unified monetary system. It consists of a set of arrangements and regulatory policies implemented by partner nations to exercise a higher degree of control over the global economic processes (Eichengreen, 2019a). The primary idea of the system is to promote global cooperation in terms of economic activities, and the International Monetary fund was established in 1945 to serve this purpose (IMF, n.d.). The organization’s duty is to ensure stability and alleviate the uncertainty of the global market, enabling access to resources for all countries. Today’s economic environment is highly complex, and perturbations in the economic sphere have the potential to affect all nations individually.
However, in the 21st century, it is often stated that the natural evolution of the global economy has rendered the current monetary system outdated and flawed. Farhi and Maggiori (2017) discuss its fundamental instability within the framework of the Triffin dilemma. It is envisioned that the system should shift toward a multipolar model, which will require substantial reform, and the process has already begun. However, Harvard experts argue that the international monetary sphere remains dollar-centered, and it is the American currency that determines most of the exchange market fluctuations (Eichengreen, 2019b). The debates continue over the future of the monetary system, but there is a unanimous opinion regarding its primary purpose of enabling the supply of international liquidity for countries (Obstfeld & Taylor, 2017). Although voices are heard in favor of reforms, today’s monetary system preserves its nature in terms of currency exchange patterns.
Floating Exchange Rate
The idea of floating exchange rates serves to reflect a natural market process. In this case value of a currency may change in comparison to others because of certain events. The pace and direction of the change follow the fundamental economic concepts of supply and demand (“What’s the difference …”, n.d.) The use of the currency worldwide, as well as intense foreign investments, contribute to the growth, whereas crises lead to depreciation. From an international company’s standpoint, flexible exchange rates contribute to the overall uncertainty of the economy. However, the model demonstrates significant advantages, as well, as, in its case, the value of the currency is determined entirely by natural economic processes. The government’s interference is non-existent, and the exchange rate tendencies fully reflect how healthy a nation’s economy is, enabling a more in-depth analysis of financial opportunities. In addition, the IMF considers the floating exchange rate to be a sign of a strong, democratic nation (“What’s the difference …”, n.d.) Therefore, despite perceived risks of instability, flexible exchange models may prompt international companies to invest in a particular nation.
Fixed Exchange Rate
In response to challenges conditioned by a possible rapid decline of a currency’s value, some nations have implemented an alternative framework. According to this principle, the exchange rate becomes fixed at a particular point or within an interval, remaining constant across time (Ambaw & Sim, 2018). In this situation, a firm may expect stability in terms of sales performance, costs, and beneficial market strategies. However, fixing an exchange rate requires the direct intervention of the government in economic affairs, thus disrupting the natural market forces. Therefore, the model contradicts the principles of developed democracies, in which markets develop independently and in accordance with the dogmas of the free economy. Research suggests that fixed exchange rates may be beneficial for developing countries, in which the economies remain subject to external impact (Obstfeld, Ostry, & Qureshi, 2018). Therefore, the presence of a fixed exchange rate is highly informative for the management of an international company, as far as the economy’s stability and the degree of state interference are concerned.
Conclusion
In conclusion, the international monetary system has been receiving increased attention due to intense globalization occurring in the 21st century. Global economic processes have become more complicated, as a greater number of player enters the market. In such an environment characterized by uncertainty, the changeability of exchange rates plays an important role. Fixed and floating models are opposite in all aspects, including origins and governmental background. The former is suitable for emerging economies, as well as firms, which see benefits in such markets. Floating exchange rates, on the contrary, are usually associated with strong, democratic states, which are not afraid to let market forces determine the value of their currency. Each model exists in a particular context, and the ability to analyze is crucial to the management of an international company.
References
Ambaw, D. T., & Sim, N. (2018). Is inflation targeting or the fixed exchange rate more effective for attracting FDI into developing countries? Applied Economics Letters, 25(7), 499–503. Web.
Eichengreen, B. (2019a). Globalizing Capital: A History of the International Monetary System (3rd ed.). Princeton, NJ: Princeton University Press.
Eichengreen, B. (2019b). Two views of the international monetary system. Intereconomics, 54(4), 233–236.
Farhi, E., & Maggiori, M. (2018). A model of the international monetary system. The Quarterly Journal of Economics, 133(1), 295–355. Web.
IMF. (n.d.). About the IMF. Web.
Obstfeld, M., & Taylor, A. M. (2017). International monetary relations: Taking finance seriously. Journal of Economic Perspectives, 31(3), 3–28. Web.
Obstfeld, M., Ostry. J., & Qureshi, M. S. (2018). Global Financial Cycles and the Exchange Rate Regime: A Perspective from Emerging Markets. AEA Papers and Proceedings, 108, 499–504. Web.
What’s the difference between fixed and floating exchange rates? (n.d.) Web.