What is a fixed exchange rate?

A fixed exchange rate refers to a system where a currency's value is tied or pegged to another currency or a standard, such as gold. This mechanism stabilizes the exchange rate, ensuring that it does not fluctuate significantly in response to market forces. By establishing a fixed value, countries can provide predictability for trade and investment, which can help to manage inflation and foster economic stability.

In a fixed exchange rate system, central banks typically intervene in the currency market to maintain the pegged rate, buying or selling their currency as required to counteract upward or downward pressure from market fluctuations. This method contrasts with a floating exchange rate, where values change based on market demand and supply. The stability offered by a fixed exchange rate can be advantageous for international trade, as it reduces the uncertainty associated with currency fluctuations.