Disadvantage of Fixed Exchange Rate system
Questionable price stability: A metallic standard is considered to promote price stability. However, some studies indicate that the gold standard era experienced large fluctuations in the average price level. These fluctuations appear to have been caused by the changes in the relative price of gold with respect to the price of goods and services.
Questionable economic stability and prosperity: Because price stability leads to economic stability and, therefore, prosperity, the usual assumption is that the metallic standard years are associated with higher growth and lower volatility in growth. One of the disastrous economic slowdowns in recent history, the Great Depression, happened under the gold standard.
Additionally, competitively contractionary monetary policies were implemented during the gold standard starting in the 18th century, which led to lower output growth and higher unemployment.
Questionable price–specie–flow mechanism: The price–specie–flow mechanism didn’t work as well in theory under a gold standard. But it really doesn’t work in a reserve currency standard. If the price–specie–flow mechanism had functioned, all countries’ current accounts would be balanced. However, during the Bretton Woods era, some countries had persistent current account surpluses, and others had current account deficits.
Theoretically, surplus countries were to lend to deficit countries. This scheme doesn’t work when countries with persistently large current account deficits also have problems repaying their loans.
