Exchange Rate Systems
NCERT Class 12 • Introductory Macroeconomics • Chapter "Open Economy Macroeconomics"
Exchange Rate Systems
The exchange rate is the price of one currency in terms of another. It decides how expensive imports are and how competitive exports become, so it links the domestic economy directly to the world economy and is watched closely by both business and government.
Types of Exchange Rate Systems
- In a fixed exchange rate system the government or central bank sets the rate and defends it by buying and selling foreign currency.
- Its advantage is certainty for traders; its drawback is that defending the rate can drain reserves.
- In a flexible or floating exchange rate system the rate is set by the demand for and supply of the currency in the market.
- Its advantage is that the market adjusts automatically; its drawback is uncertainty and volatility.
- A managed float lets the market set the rate while the central bank intervenes to smooth sharp swings, which is the common practice today.
- Under a fixed system, an official reduction in the value of the currency is called devaluation, and an increase is called revaluation.
- Under a floating system, a market fall in value is called depreciation and a rise is called appreciation.
Effects of a Change in the Rate
- When the rupee depreciates, exports become cheaper for foreign buyers and imports become costlier at home.
- That helps exporters and those competing with imports, and hurts importers and travellers going abroad.
- Costlier imported crude oil and fertiliser can feed into domestic inflation.
- When the rupee appreciates, imports become cheaper but exports become less competitive.
- Foreign investment flows, interest rate differences and trade balance all move the exchange rate.
- A stable and predictable rate helps exporters plan and price their contracts with confidence.
- Current account convertibility allows free exchange for trade, while capital account convertibility is opened more cautiously.
| Term | System | Meaning |
|---|---|---|
| Devaluation | Fixed | Official reduction in currency value |
| Revaluation | Fixed | Official increase in currency value |
| Depreciation | Floating | Market fall in currency value |
| Appreciation | Floating | Market rise in currency value |
Exchange rate — the price of one country's currency expressed in terms of another country's currency.
Hindi me samjhein
अवमूल्यन सरकार का निर्णय है और स्थिर प्रणाली में होता है। मूल्यह्रास बाजार में स्वयं होता है और तैरती प्रणाली में। दोनों का प्रभाव मिलता-जुलता है पर कारण अलग है।
Exam me kaise aata hai
- Official reduction in currency value is called — devaluation
- Market fall in currency value is called — depreciation
- A system where the market sets the rate is — floating exchange rate
- When the rupee depreciates, exports become — cheaper for foreign buyers
UPSC/State PSC ke liye
- Depreciation helps exports only if the export supply can actually respond; otherwise it mainly raises the import bill.
- A managed float tries to capture the market's adjustment while avoiding the volatility that harms trade contracts and investment planning.
Yahan confuse hote hain
✗ Devaluation and depreciation are identical | Devaluation is an official decision; depreciation is a market movement | ✓
✗ Depreciation makes imports cheaper | It makes imports costlier | ✓
✗ A floating rate needs no central bank at all | Central banks usually intervene to smooth sharp swings | ✓
Ek nazar me
- Exchange rate is the price of one currency in another.
- Fixed, floating and managed float are the three systems.
- Devaluation and revaluation are official; depreciation and appreciation are market driven.
- Depreciation aids exports and raises the cost of imports.