• Freedom to Use Monetary Policy: Governments can raise or lower interest rates to boost or cool the economy.
  • Loose Money Example: When the economy's down, lower interest rates can boost spending. Think of a sale at your favorite store, so people buy more!
  • Tight Money Example: When prices are skyrocketing, higher interest rates slow spending. Like raising the price of video game tokens, so people play less.
• Self-Correcting Trade Deficit: If a country imports more than it exports, the currency value falls, making exports cheaper and imports costlier.
  • Example: Imagine American toys becoming cheaper in Europe, so more are sold, while European chocolate becomes expensive in the U.S., reducing purchases.
• Smooth Adjustments: Currency changes are usually gentle, avoiding sudden shocks.
• No Need for Huge Reserves: The central bank doesn't need a big piggy bank of foreign currencies.

• Unpredictability: Exchange rates can fluctuate wildly.
  • Example: It's like a roller coaster, sometimes fun for thrill-seekers (speculators), but not so much for businesses that need stability.
• Risk for Small Players: Small businesses and investors might find the risks too high.
• Potential Inflation: Governments might pursue growth at the expense of rising prices.
  • Example: Printing more money to fuel growth might lead to all prices (even your favorite comics) going up!

Exchange rates are locked in place, like having a permanent price tag on that candy bar!

Advantages

• Stability for Businesses and Investors: It's easier to plan when you know what the future holds.
• Control Over Inflation: Governments have to be careful with their spending and borrowing.
• Encourages Efficiency: Firms must keep their costs down as they can't rely on currency shifts to help them.
  • Example: Think of a soccer team practicing hard to win instead of hoping the other team's star player gets injured.