4.5.6 (HL)—Fixed versus floating exchange rate systems

A fixed rate offers predictability and can discipline inflation, but it requires reserves and sacrifices independent monetary policy. A floating rate preserves adjustment through the exchange rate and monetary autonomy, but creates uncertainty and may overshoot.

The better choice depends on trade exposure, financial credibility, shock type, reserve capacity and labour or fiscal flexibility. A small open economy with a highly mobile financial sector faces a different trade-off from a large diversified economy; there is no universal winner.