Q.Identify which of the following is not one of the merits of fixed exchange rate system. (A) Ensures stability in exchange rate (B) Possibility of under or over valuation of foreign currency (C) Prevents speculations in foreign exchange market (D) Coordination of macroeconomic policies becomes convenient

A fixed exchange rate system is one in which the government or central bank pegs the domestic currency to a foreign currency (or basket of currencies) at a declared rate and intervenes to maintain that rate.

The merits typically cited for this system include:

• Stability: The exchange rate remains constant or moves within a narrow band, eliminating uncertainty for international traders and investors.
• Reduced speculation: Because the rate is fixed, there is little room for speculative attacks based on expected currency movements.
• Policy discipline: Governments must coordinate macroeconomic policies (fiscal and monetary) to defend the peg, which can impose useful discipline. …

A fixed exchange rate system pegs the domestic currency to a foreign currency (or a basket) at an officially declared rate. The central bank intervenes in the forex market—buying or selling reserves—to defend that peg. This arrangement carries distinct advantages and disadvantages, and the question tests whether you can spot the wolf in sheep's clothing: a statement that describes a flaw rather than a merit.

The genuine merits

Stability in exchange rate (option A) is the headline benefit. Importers, exporters, and investors face no day-to-day currency risk; a rupee today buys the same amount of dollars tomorrow. This predictability encourages international trade and long-term capital flows, because firms can plan without hedging costs.

Prevention of speculation (option C) follows naturally. When the rate is fixed and the central bank credibly defends it, there is little room for speculators to bet on short-term swings. The one-way bet disappears—at least until a crisis forces a devaluation—so destabilizing hot-money flows are dampened.

Coordination of macroeconomic policies (option D) becomes easier because countries that peg to the same anchor (say, the dollar or gold) implicitly synchronize their monetary policies. Inflation rates converge, interest-rate differentials narrow, and fiscal discipline is enforced by the need to maintain reserves. The Bretton Woods system (1944–1971) illustrated this: member countries aligned policies to keep their parities stable.

The impostor: over- or under-valuation

Option B—possibility of under- or over-valuation of foreign currency—is not a merit; it is a structural weakness of fixed rates. …