Fixed rates give certainty; floating rates give flexibility.
Fixed
- Certainty for traders and investors.
- Discipline: the peg fails if inflation runs high.
- Needs large reserves; monetary policy is tied to the peg.
- Can be attacked: the UK left its peg in 1992 after heavy selling.
Floating
- Adjusts by itself: a deficit pushes the currency down.
- No reserves needed.
- Interest rates are free to fight inflation or recession.
- But it can swing sharply, making trade and investment riskier.
The points to remember
- Write it like this: "A fixed rate gives certainty but needs reserves and gives up independent monetary policy."
- "A floating rate adjusts automatically but can be volatile."
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A floating rate can correct a trade deficit with no one in charge.
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When each suits a country
Fixed
Small, open economies trading mostly with one partner; a history of high inflation.
Floating
Large economies with their own business cycle and trusted central banks.
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Paper 1 asked this in May 2025, as part (a) for 10 marks.
Explain the difference between a floating and a fixed exchange rate system.
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How the 10 marks are given
| Marks | What your answer needs |
|---|---|
| 9–10 | Theory fully explained, terms used correctly all the way through, the diagram included and fully explained |
| 7–8 | Theory explained, terms mostly right, the diagram included and explained |
| 5–6 | Theory partly explained, some terms, the diagram included |
| 1–4 | Theory only described or stated; few relevant terms |