Q.Distinguish between a Fixed Exchange Rate system and a Flexible (Floating) Exchange Rate system.

The two systems differ in who actually decides the exchange rate, which is exactly what drives their different trade-offs.

Fixed Exchange Rate System: the government or central bank officially fixes the value of the domestic currency against a reference currency (or gold) and actively intervenes (buying/selling foreign exchange reserves) to maintain that level. Advantage: provides certainty for international trade and investment planning. Disadvantage: requires the central bank to hold and use substantial foreign exchange reserves to defend the fixed rate, and the rate cannot adjust automatically to changing economic conditions.

Flexible (Floating) Exchange Rate System: the exchange rate is determined purely by the ordinary forces of demand and supply for the currency in the foreign exchange market, with no official intervention to hold it at a specific level. Advantage: the rate adjusts automatically over time to help correct trade imbalances. Disadvantage: exchange-rate volatility can make trade and investment planning less certain, since the rate can move unpredictably.

Most major currencies today, including the Indian rupee, operate under a managed float — a flexible system where the central bank occasionally intervenes to smooth out excessive short-term volatility, without committing to defend any single fixed level.

Assuming all countries use a purely fixed OR purely floating system — many countries, including India, use a 'managed float', a hybrid where the rate is mostly market-determined but the central bank intervenes occasionally.