Introduction
An exchange rate is the price of one currency expressed in terms of another. It is a crucial element of international economics, influencing trade, investment, and the overall competitiveness of a nation. Exchange rates can fluctuate significantly, impacting businesses, consumers, and governments. There are two primary exchange rate systems: fixed and floating. Fixed exchange rate systems aim to maintain a currency's value against another currency or a basket of currencies, while floating exchange rates are determined by market forces of supply and demand.

Factors Affecting Exchange Rates in Different Systems
1. Floating Exchange Rate Systems
In floating exchange rate systems, currency values are determined by market forces. The interplay of demand and supply for a currency dictates its value against others.

a) Demand and Supply: Several factors influence the demand and supply of a currency, leading to changes in its value:

⭐Trade flows (exports & imports): When a country exports more goods and services than it imports, it generates a demand for its currency as foreign buyers need it to pay for these exports. This appreciation of the currency makes its exports relatively more expensive, potentially reducing demand for them in the future. Conversely, a trade deficit (importing more than exporting) puts downward pressure on the currency.
⭐Foreign investment (FDI & portfolio): Foreign direct investment (FDI), such as setting up factories or acquiring companies, and portfolio investment, such as buying stocks or bonds, increase demand for the target country's currency. This is because investors need the currency to make their investments. The influx of capital strengthens the currency, potentially attracting further investment. However, if investors lose confidence in the economy, they may withdraw their investments, leading to currency depreciation.
⭐Speculation: Speculators can play a significant role in exchange rate movements, particularly in floating systems. They buy currencies they believe will appreciate and sell those they expect to depreciate. This can create self-fulfilling prophecies, as a large number of speculators acting on the same expectation can influence the actual exchange rate.

b) Economic Performance: A country's economic performance significantly impacts its exchange rate. Several factors contribute to this:

⭐Economic growth and its influence on interest rates: When an economy grows, interest rates tend to rise. Higher interest rates attract foreign investment as investors seek higher returns on their investments, leading to an appreciation of the currency. Conversely, a slow-growing economy often features lower interest rates, which can make the currency less attractive to foreign investors and lead to depreciation.
⭐Inflation rates and purchasing power parity: Countries with higher inflation rates tend to see their currencies depreciate. This is because inflation erodes the purchasing power of a currency, making goods and services more expensive relative to other countries. The concept of purchasing power parity (PPP) suggests that the exchange rates should adjust to reflect the differences in price levels between countries. If inflation is higher in one country, its currency should depreciate to maintain PPP.
⭐Government policies (monetary & fiscal): Monetary policy, which involves managing interest rates and the money supply, can impact exchange rates. For example, raising interest rates can attract foreign investment and strengthen the currency. Fiscal policy, which focuses on government spending and taxation, can also influence exchange rates. For instance, increased government spending can lead to higher economic activity and potentially a stronger currency.


2. Fixed Exchange Rate Systems
In fixed exchange rate systems, governments aim to maintain a specific value for their currency against another currency or a basket of currencies. This typically involves intervention by the central bank to influence the exchange rate.
a) Government Intervention: Central banks play a crucial role in maintaining a fixed exchange rate. They use various tools to influence the supply and demand for their currency:

⭐Buying and selling foreign exchange reserves: Central banks hold foreign exchange reserves (currencies of other countries). When a currency is under pressure to depreciate, the central bank can buy its own currency using its reserves, increasing demand and supporting the exchange rate. Conversely, to prevent appreciation, the central bank can sell its domestic currency, causing it to depreciate.
⭐Manipulating interest rates: Central banks can adjust interest rates to make their currency more or less attractive to investors. Raising interest rates makes investing in the country more appealing, attracting foreign capital and strengthening the currency. Lowering interest rates can discourage investment and potentially lead to depreciation.
⭐Imposing capital controls: Governments may implement capital controls to limit the flow of capital in and out of the country. This can be used to stabilize the exchange rate by restricting speculative movements or preventing large capital outflows.

b) External Factors: Fixed exchange rate systems are susceptible to external factors that can challenge the government's efforts to maintain the exchange rate:

⭐Global economic shocks: Global economic shocks, such as recessions or financial crises, can lead to significant changes in capital flows and demand for currencies. These shocks can make it challenging for central banks to maintain the fixed exchange rate.
⭐Political instability: Political instability, such as wars or regime changes, can lead to capital flight and currency depreciation. Investors may lose confidence in the country's economic prospects, leading to a decrease in demand for its currency.
⭐Speculative attacks: Speculators may target fixed exchange rate systems, taking advantage of vulnerabilities. If speculators believe that a currency is overvalued and likely to depreciate, they can sell the currency, putting downward pressure on its value. This can force the central bank to use its reserves to defend the exchange rate, potentially exhausting its resources and leading to a breakdown of the fixed system.


Comparison and Contrast
Both fixed and floating exchange rate systems have advantages and disadvantages. Floating systems offer greater flexibility and allow for automatic adjustments in response to economic changes. However, they can be subject to volatility and uncertainty, which can make it challenging for businesses to plan for the future. Fixed systems provide stability and predictability, which can benefit businesses and investors. However, they require significant government intervention and can be vulnerable to speculative attacks.

Conclusion
Exchange rate movements are influenced by a complex interplay of factors, including demand and supply, economic performance, and government policies. The choice between fixed and floating exchange rate systems involves trade-offs between stability and flexibility. The global financial system is constantly evolving, and exchange rate dynamics are continually adapting to changing economic conditions and policy decisions. Understanding the determinants of exchange rate movements is crucial for businesses, investors, and policymakers alike.

Sources
• <a href="https://www.investopedia.com/terms/f/foreignexchangerate.asp">Investopedia: Foreign Exchange Rate</a>
• <a href="https://www.investopedia.com/articles/basics/101014-what-you-need-to-know-about-exchange-rates.asp">Investopedia: What You Need to Know About Exchange Rates</a>
• <a href="https://www.economicshelp.org/macroeconomics/exchange-rates/fixed-exchange-rate/">Economics Help: What is a Fixed Exchange Rate?</a>
• <a href="https://www.economicshelp.org/macroeconomics/exchange-rates/floating-exchange-rate/">Economics Help: What is a Floating Exchange Rate?</a>
• <a href="https://www.bankofengland.co.uk/knowledgebank/exchange-rates">Bank of England: Exchange Rates</a>