What Are The Pure Flexible Exchange Rates?

At one extreme is an international monetary system in which exchange rates are completely flexible and move purely under the influence of supply and demand. This system known, as flexible exchange rates, is one where governments neither announce an exchange rate nor take steps to enforce one. In a flexible exchange rate system, buying and selling among households and businesses determine the relative prices of currencies.

Let us see how exchange rates are determined under flexible rates. In 1994, the peso was under attack in foreign exchange markets, and the Mexicans allowed the peso to float. At the original exchange rate of approximately 4 pesos per U.S dollars, there was an excess supply of pesos. This meant that at that exchange rate the supply of pesos by Mexicans to buy American and other foreign goods and assets outweighed the demand for pesos by Americans and others who wanted to purchase Mexican goods and assets.

What was the outcome? As a result of the excess supply, the peso depreciated relative to the dollar. How far did the exchange rates move? Just far enough so that at the depreciated exchange rate of about 6 pesos to the dollar the quantities supplied and determined were balanced.