Give reasons, supported with clear explanations, why countries opt for a floating exchange rate?
The exchange rate is the rate at which domestic currency is exchanged with foreign currency in the currency exchange market. The currency exchange market is the market where the currencies are bought and sold. The exchange rate explains the quantity of the domestic currency required to be paid in order to receive a unit of foreign currency in the currency exchange market.
The floating exchange rate is the system of determining the exchange rate of the currency based on the demand for the currency in the exchange rate market and the supply curve of the currency in the exchange rate market. The currency price of the domestic currency is determined based on the supply and demand for the currency in the foreign exchange market. The countries were using the fixed exchange rate system prior to the floating exchange rate system under which the exchange rate was predominantly determined by the government of the country.
The fixed exchange rate system is the system which became obsolete due to the market failure. The government determination of the exchange rate makes difficulties because of the fact that the rate remains fixed up to the point where the government or the central bank decides to make changes. The floating exchange rate system is becoming more popular due to the fact the market automatically adjusts the exchange rate when there is increase or decrease in the demand and supply for the currency in the exchange market.
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