Types of exchange rate
An exchange rate comparative price of one currency compared to another. The most common comparison is to the US dollar. How the exchange rate is made by two systems:
Floating exchange rates is where the forces of demand and supply determine the value of an exchange
Fixed exchange rates where the government/central bank sets the value of currency relative to the US dollar. The fixing of the exchange can be quite strict or allow some flexibility.
Key reference is here. Use example of bargaining in a local This market.
Why use floating exchange rates
Below are the advantages of a floating exchange rate
Monetary policy flexibility that is using interest rates to manage the economy mainly inflation
Resilience against trade shocks
Central bank maintains seignorage and lender of last resort
Avoiding exchange rate risks
The disadvantages are:
reduced trade competition appreciation and depreciation.
Takes control of inflation
Stop speculative bubbles for example US 1985
Reduces uncertainty and promotes trade.
Why have a fixed exchange rates
Fixed exchange rate are great for developing and small countries for the following reasons
Managing an economy
less speculation - reduced ability for people to gamble on your currency falling or rising
Achieving certainty so that investors and consumers which creates a good business environment
The costs of such a system are:
Harder to control inflation because interest rates are not effective
Getting the target wrong has negative impacts on the economy for international trade, and attracting investors
Key reference number 1
Key reference number 2
Nigeria's road to fixed exchange rate
Nigeria has a long history of having flopping between fixed and floating exchange rate systems. This year June 2023 the government has moved to float the naira. In 2016 they tried to float the naira that was shortlived and there has been many attempts before.
Key references are here and here and here.
Nigeria had a huge arbritage potential, the black market and the offical market had a huge price differential.