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The Law of One Price in PPP Theory

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A managed floating exchange rate is crucial for not only economic restructuring but also optimization of allocation of resources. This is because an exchange rate symbolizes price relations that exist between non-tradable and tradable goods and services. A regime of managed floating exchange rate improves the effectiveness of resource allocation, direct resources to the economic sectors that are mainly fuelled by domestic demand, for instance, the services sector, promotion of industrial upgrading, transformation of the economic pattern development, reduction of trade imbalances together with over-reliance on exports, all these stimulate economic demand to have an influential role in economic development and hence leads to promotion of balanced and sustained economic growth(Siddaiah, 2010). A managed foreign exchange rate regime also improves and strengthens macroeconomic policy-making.

A managed floating exchange rate regime thus can assist in enhancing the capability and proactiveness of macroeconomic management as well as the efficiency of monetary policy, control asset bubbles and inflation together with containing macroeconomic risks. All these form a very conducive environment for business growth and prosperity implying a managed foreign exchange rate is suitable for companies in such countries.

Lastly, a floating exchange rate regime creates long-term fundamental interests by deepening reforms, opening up and adoption of the new development pattern. In addition, it leads to enhancement of market-based institutional arrangements as well as a financial regulation which improves resilience particularly of the corporate sector (Siddaiah, 2010). A fixed exchange rate is also at times known as a pegged exchange rate and is a kind of exchange rate regime whereby one currency’ s value is usually fixed against either a basket of some other currencies, to the value of another single currency or rather to a further measure like gold.

This kind of exchange rate regime has its own risks as well as benefits.  

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