Fixed exchange rate is the name given to the exchange rate regime adopted by countries that, using a foreign currency as a reference, maintain the fixed exchange rate as defined by the government.
Unlike what happens in the floating exchange rate (the opposite exchange rate regime), the fixed exchange rate does not obey the changes occurred in the financial market, nor the variations in the law of supply and demand. The only corrections made to the rate are one-off and spaced.
The regime became popular in the 19th century, when the referential was still the gold standard. In the twentieth century, after the two Great Wars and the rise of the United States in the economy, the dollar pattern emerges – which, although it was mitigated with the spread of the fluctuation model, guarantees that the dollar is still the most used currency as a reference.
In Brazil, the period best known for adopting the fixed exchange rate was between 1994 and 1998, when Fernando Henrique Cardoso was still Minister of Finance and until his first term as President of Brazil.
Its establishment even reveals one of the main functions of the fixed exchange rate: to be used as a measure of inflationary control.
However, its critics argue that even its efficiency in this regard must be put into perspective, so as to be a one-off measure in economies of uncontrolled inflation.
How did the fixed exchange rate develop around the world?
Beginning in the 19th century, the fixed exchange rate dominated a large part of Western economies with the idea of a state-controlled exchange.
At that time, the first reference for quotes was gold. That is, each of them established the value that their national currency would have against it, which started the period known as the gold standard.
In the 20th century, we went through the dollar standard and the predominance of the floating exchange rate.
Even so, several countries have continued to adopt the regime over the decades – more or less successfully (believe me, there are examples in every successful range).
In China, for example, the fixed exchange rate was considered essential for the country’s strong development. The devaluation of the dollar against the renminbi made it possible for Chinese exporters to become competitive in the international market, flooding the shelves of the world with their products in practically all areas.
In Brazil, on the other hand, the best known (and most recent) experience of the fixed exchange rate occurred in the 1990s. For about 4 years, the government controlled the price and stabilized the economy, after an entire decade of hyperinflation. In the end, when the tactic no longer seemed to work and threatened to hamper economic growth, it was abandoned.
But the most critical example was seen in Argentina. Unpayable external debt (in dollars), freezing of bank deposits, declaration of public debt moratorium… A set of disastrous conditions that, on the one hand, made it impossible to maintain the dollar-1 parity for a peso maintained until then and, on the other, made their abandonment unimaginable. The country returned to the floating exchange rate regime only in 2001.
How do fixed and floating exchange rate regimes interact with each other?
Both the fixed and floating exchange rate regimes are considered to be opposite. Still, it is very difficult for a single country to adopt them completely and solely over a long period.
Therefore, the normal thing is to move between each one according to the exchange policy adopted and to experience variations within them.
The main one concerns the flexibility of the model created around the floating exchange rate.
According to the so-called “dirty fluctuation”, the market is free to define the exchange rate, according to the principles of supply and demand, but the government uses specific strategies to control it. Based on the manipulation of the amount of dollars available, the Central Bank controls the quotation – which is very similar to the control model established in the fixed exchange rate, do you agree?