The exchange rate, which is the external value of the domestic currency, can be implemented by two different systems. In a floating exchange rate system, the values of currencies are determined by demand and supply in the foreign exchange market, with no government intervention. In a fixed exchange rate system, the government intervenes to maintain the exchange rate with buying and selling its own currency, or the manipulation of interest rates.
             Most developed countries in the world today use the floating exchange rate system. Here, the exchange rate automatically adjusts so that the supply and demand of the currency are in equilibrium. This leads to a self-correcting balance of payments, eliminating deficits or surpluses. A rise in imports leads to an increase in the supply of pounds and the exchange rate falls, with the opposite effects for exports. This though, needs to be under the condition that the price elasticity of imports and exports are greater than one, which is not always the case depending on the industry or the nature of the good. In a floating system, the government can pursue its own domestic policies, such as adjusting its interest rates more freely, without the pressure of needing to maintain its currency at a certain value. There is also no need for the central bank to keep foreign reserves. The argument against this is that governments are not forced to control their economies; for example, they do not have to sustain inflation in line with other countries to ensure competitiveness of their firms, as the currency can just depreciate. Speculation on future movements can lead to major changes in the rate, and the instability floating exchange rate brings may deter investment and trade. However, imported inflation can be prevented whereas under a fixed exchange rate, higher prices will be passed on.
             Fixed exchange rates provide stability for firms and households, which is more encouraging to investment and trad
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