Explain Why Do Developing Countries Need Fixed Exchange Rate
This essay will discuss the statement do developing countries need fixed exchange rates. Firstly, as part of this introduction it will define what developing countries are and explain what an exchange rate is. Secondly, it will explain what the different types of exchange rate there are. Thirdly, it will describe the advantage of a fixed exchange rate. Fourthly it will discuss the disadvantage of a fixed exchange rate. Lastly, it will decide if fixed exchange rates are needed by developing countries and why that is.
A developing country can be defined as: “a nation with a lower standard of living, underdeveloped industrial base, and low Human Development Index relative to other …show more content…
If there is a floating exchange rate, there can be a lot of money that comes to a country because it pays higher interest rates in the short term. This can make the currency to go up in value against other currencies (Wälti, 2007). On the other hand, if there is a low interest rate, the opposite can happen and money can leave the country and cause the currency to have a lower value. If a currency goes up in value, it becomes more expensive for foreigners to buy goods from the country. This makes it harder to compete when selling goods abroad. At the same time and in the opposite way, if a currency goes down in value, industries which export a lot of goods get cheaper which makes them richer (Kouparitsas, 1998). When currencies get weaker or stronger, if it is as a result of what is happening to other countries or because they have found a way to become more efficient, then this might not be a problem. On the other hand, if the exchange rates that float can go up and down because of investors who want to make money due to interest rates in the short term, this may cause problems for the country as the currency could become too weak or too strong compared to the way the economy is. If a country has a fixed exchange rate, this wouldn’t happen because it’s not possible to move the exchange rate because of the central bank taking action if the rate moves. In …show more content…
Because of this, they will not easily be able to compete with other rich countries when they are selling their goods to foreigners. By having a fixed rate, they can have their currency cheaper on purpose. This makes it easier to sell their goods to a foreign country cheaply and make money. This makes it more expensive to import things too, which means that people will choose to buy things from domestic suppliers. This therefore helps the country’s economy to have more employment (Rebelo and Végh Gramont, 2006).
Another thing for developing countries is that they may have to deal with high levels of inflation (Cowen 2013). This is because they have been poorly managed such as through money printing or they have a high level of economic growth which causes wages to increase. By having a fixed currency rate, they would not necessarily have high levels of inflation because the rate of inflation would be more similar to the country they fixed the currency too (Asici, Ivanova and Wyplosz,