Importance of Exchange Rates

Exchange rates establish relationships between the different currencies or monetary units of the world.

Exchange rates have been instrumental in developing international trade. These have considerably increased the tempo of international investments.

They provide a direct link between domestic prices of commodities and productive factors and their prices in the rest of the world.

With the prices at home and abroad at a given level, a low rate of exchange will hamper imports and stimulate exports, and thereby tend to bring about a balance of payment surplus.

Floating Rate of Exchange

Floating rate which is allowed to fluctuate freely according to supply and demand forces. Such float is Free Float if no intervention takes place by the central bank of the country. In the real world some degree of intervention exists which leads to a managed float, such managed floats are either single or joint. Dollar, Sterling and Yen were floating with varying degree of intervention within a band of 2.25% on either and they are singly floats. The European common market countries (Germany, France, Belgium, Netherlands, Luxemburg, Ireland, Demark and Sweden) are under a joint float within a narrow bank called “Snake in the Tunnel”. The new IMF policy is to keep relatively stable exchange rates within a wider band of fluctuations. Indian rupee is kept relatively stable with the help of a basket of Currencies up to July 1991. When the rupee was devalued and LERMs was adopted later. (Limited Exchange Rate Management System).