Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

7. Controls inflation: 
Fixed exchange rate helps to maintain the external value of 
the currency stable and thus controls inflation. It prevents the 
Government of the countries form adopting inflationary policies. 
Generally, GOI have often been tempted to pursue undue 
expansionary fiscal and monetary policies to lower unemployment 
and create boom conditions. 
(b) DEMERITS: 
1. Lacks adjustment mechanism: 
The greatest defect of this system is that it lacks adjustment 
mechanism. This puts a great strain on the reserves of participating 
countries. The problem of this system is that to know to what extent 
exchange rate should be fixed.
2. Difficult in real sense: 
This system has to be supervised by an authority of the 
national government and international authority. There is also a 
problem of division of power between the two authorities to 
maintain fixed exchange rates. 
3. Problem of liquidity 

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It creates problem of liquidity. Hence there had to be 
variations in exchange rates. It is found in the flexible exchange 
rates. 
 
4. Rigidity: 
This exchange rate has been found more rigid and thus may 
create problem in promoting international trade. it prevents growth 
of multilateral trade being rigid in its nature. 
10.2.2 Flexible exchange rate system? Its merits and demerits. 
In this system exchange rate go on fluctuating according to 
the demand and supply of it in the world market. Exchange rate is 
determined according to the free forces of demand and supply of
foreign currencies. This system is quit suitable for the countries like 
USA. This rate is set where the demand for exchange and supply of 
exchange is in equilibrium.