Fixed Exchange Rate Definition

When the central bank or the government bounds the official exchange rate to the currency of another country or the gold prices, a situation called a fixed exchange rate arises. This tends to limit the value of a currency within a slight band.

A Little More on What is a Fixed Exchange Rate

Fixed rates tend to lead to low inflation, keeping interest rates low in the long run, and increasing investment. Developing economies tend to adopt fixed rates to ensure stability, reduce speculation, and to encourage investors. However, this system blocks central banks from making strategic adjustments in interest rates as per economic need. Fixed rates also require large currency reserves to back the currency in times of pressure. The Bretton Woods Agreement, employed after WWII until the 1970s, linked member nations exchange rates to the US Dollar value, which was fixed to gold prices. The gold era ended in 1973 and was replaced by floating rates. In 1979, the European Union was created along with the Euro currency. The EU also launched the European Exchange Rate Mechanism (ERM) as part of the Europen Monetary System (EMS). The member nations (including France, Italy, Spain, Netherlands and Germany) consented to follow +/- 2.25% currency rates. The system was designed to reduce exchange rate variability. The UK, joined 1990 but withdraw after 2 years.

References for Fixed Exchange Rates

• https://en.wikipedia.org/wiki/Fixed_exchange-rate_system
• https://www.investopedia.com/terms/f/fixedexchangerate.asp
• http://www.businessdictionary.com/definition/fixed-exchange-rate.html