The value of the UK pound is currently determined on a floating Essay

The value of the UK pound is currently determined on a floating exchange rate system, but in the past has been determined on a f - Essay Example In this essay, the fixed exchange rate system and the role of UK in maintaining the pound under the fixed exchange rate system has been discussed. Moreover, to analyse the current exchange rate system adopted by UK, floating exchange rate system has been discussed. Finally, the impact of depreciation of British Pound on the UK economy has been analysed by using relevant data, graphs and tables. Fixed Exchange Rate System In the fixed exchange rate system, the rates fluctuate within narrow boundaries and if the exchange rate starts to move higher, the government maintains the rate within the boundaries (Madura, 2008). In 1944, Bretton Wood Accord introduced the fixed exchange rate system and until 1970s, most of the major world economies were participating in the fixed exchange rate system (Burton & Brown 2009). Burton & Brown (2009) explains that after the introduction of the system, the major industrialised countries met to develop a new international financial system. Under the fix ed exchange rate system, economies agreed that if the trade deficit of an economy increased then they would be able to manage supply of currency in international markets. In the fixed exchange rate system, the government increases the supply of currency when the trade deficit of the country increases. The increased supply of the currency inserts the downward pressure on the exchange rate however, to maintain the pre-decided exchange rate, the central bank of the country purchase the excess supply of its currency. For example, if Britain economy faces trade deficit, the increase in the supply of pounds relative to dollar inserts downward pressure on pound value whereas, decrease in supply of pounds relative to dollar inserts upward pressure on value of pound. The government has the power to intervene in the fixed exchange rate system. Under a fixed exchange rate system, the government is able to manipulate the market value of the other currency in terms of its domestic currency. Howe ver, manipulations can be only done to an agreed-exchange rate. UK government has been playing a significant role in maintaining pound under a fixed exchange rate system. The UK government has always been intervening to keep the agreed-exchange rate within certain boundaries. For example, when the agreed-exchange rate of pound and dollar fluctuated then to keep the rate fixed, the UK government bought or sold pounds with dollars until the market value of the two currencies converged to an agreed level. Floating Exchange Rate System Floating exchange rate system is the system when there is no flexibility in the exchange rate system and the values of exchange rate system are determined by the market forces and they are independent of the government intervention (Madura, 2008). British government adopted the floating exchange rate system in 1992 and after adopting the floating exchange rate system, the Bank of England was no longer able to influence the currency markets. In other words , after adopting the floating exchange rate system, the influence of the government in controlling the exchange rate system finishes. In this exchange rate system, the value of the currency is only determined by the demand and supply of the currency in the foreign exchange market, therefore, market forces play role to influence the