How Fixed Exchange Rates Work
Governments or central banks set fixed exchange rates based on a benchmark currency. They then intervene in the foreign exchange market by adjusting their own currency’s value to maintain that fixed rate. This often involves holding large reserves of foreign currencies to manage fluctuations effectively.
How Floating Exchange Rates Work
Floating exchange rates operate through supply and demand dynamics. When demand for a currency rises, its value increases; conversely, if demand falls, so does its value. Factors influencing this include Inflation rates, interest rates, and economic indicators.
From my analysis, this system is often more responsive to changes in economic conditions, making it easier for countries to adjust to economic shocks. However, this volatility can lead to uncertainty for businesses and investors.
Depreciation Vs Devaluation – Full Detail Video Available in our Youtube Channel
What is Depreciation ?
- Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
- Rupee depreciation means that the rupee has become less valuable with respect to the dollar.
- It means that the rupee is now weaker than what it used to be earlier.
For example: USD 1 used to equal to Rs. 80, now USD 1 is equal to Rs. 87, implying that the rupee has depreciated relative to the dollar i.e. it takes more rupees to purchase a dollar.
Depreciation Vs Devaluation:
- If the value of the Indian Rupee is weakened through administrative action, it is devaluation.
- While the process is different for depreciation and devaluation, there is no difference in terms of impact.
- India used to follow the administered or fixed rate of exchange until 1993, when it moved to a market-determined process or floating exchange rate.
- China still adheres to the former.
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