Fixed Rate Exchange:

A fixed exchange rate is an exchange rate regime in which the value of a particular currency is attached to the value of another currency or a group of currencies. In certain cases the value may also be pegged to gold. The value of the particular currency that has been pegged to another one depends on the performance of the same, which is also known as the reference value. One of the major implications of the fixed exchange rate is that it does not let a government create and adhere to a particular financial policy that is free from external influences and is necessary for achieving domestic economic stability. There are certain conditions whereby the fixed exchange rates are preferred for the fact that they are highly stable. Countries which adopt the fixed exchange rate regime need to be careful with the entire exercise because they have to make sure that they hold on to the various imperatives of such policies. These countries will also need to have a fair degree of confidence on the capital markets. Otherwise there are chances that the entire exercise may be a complete failure. When a government tries to institute a fixed exchange rate regime there are certain steps it has to take. Most of the times, the governments either sell or purchase their currencies in the open financial markets. One of the main reasons behind a government maintaining foreign currency reserves is to facilitate the entire process. In case the exchange rate goes down well below the expected rate, the government purchases the domestic currency using its reserves. This leads to an increase in the price of the currency as there is an increase in the demand for the currency in the financial markets. In case the rate of exchange exceeds the expected level then the government will sell its foreign reserves.