What are the advantages and disadvantages of a fixed versus a flexible exchange rate regime?

I think the Mundell Fleming rule clearly captures and explains the dynamics here. If you maintain a pegged system of exchange rate, you enjoy price stability and some degree of certainty and predictability, as well as reduced exchange risks. However, you can not have all that and enjoy free capital flow or mobility and an independent monetary policy regime or monetary policy autonomy. This means vulnerability to speculative attacks and inability to respond to economic shocks.

Fixed rates/pegs are hard to maintain. Aside from Greece, here are 3 examples of failed pegs. First, the Chinese yuan was pegged to the USD until 2005 when trade imbalances/accusations of currency manipulation made this untenable. It moved to a ‘managed’ system to retain control over export attractiveness. Even so, the yuan has appreciated. Second, the Argentinian peso was pegged to the USD until trade imbalances/hyperinflation led the Government to break the peg in 2002, which led to a sharp devaluation. My personal favourite, the Swiss Franc was pegged to the euro until 2015 when unsated demand for it (due to eurozone crisis) led to the Swiss National Bank abandoning the peg. This caused massive appreciation/FX imbalances.

A fixed exchange rate regime offers stability, which is great for international trade and investment. For example, countries pegging to the euro enjoy reduced currency fluctuation risks. This stability helps businesses plan long-term investments confidently. However, I’ve seen significant downsides too. Countries lose control over their monetary policy, like those pegging to the euro before fully joining the Eurozone, limiting their ability to respond to economic changes. Fixed rates can attract speculative attacks and lead to economic instability. Additionally, they can cause trade imbalances, as countries can't adjust their exchange rates to reflect economic conditions.

A flexible exchange rate regime allows currencies to fluctuate based on market forces, which I find offers significant advantages. For instance, countries like the UK benefit from having the pound float freely. This flexibility lets them adjust their monetary policy to suit economic conditions, such as lowering interest rates to stimulate growth during a downturn. However, there are downsides too. Exchange rate volatility can make international trade and investment riskier, as businesses face uncertainty over currency values. I’ve seen how this can complicate long-term planning. Additionally, countries with weak economic fundamentals may experience rapid devaluation, leading to inflation and instability.

The impossible trilemma has important implications for policymakers, as it highlights the inherent trade-offs and constraints faced in managing macroeconomic policies in an open economy. Policymakers must carefully weigh the costs and benefits of different policy choices and consider the trade-offs between monetary policy autonomy, exchange rate stability, and capital mobility when designing economic policy frameworks. In practice, countries often make trade-offs between these policy goals based on their economic priorities, institutional constraints, and external circumstances.

One important aspect to consider is the impact of global economic events on exchange rate regimes. For example, during the 2008 financial crisis, countries with flexible exchange rates could adjust their monetary policies more freely to stabilize their economies. Conversely, those with fixed rates faced greater challenges due to their limited ability to respond quickly. This highlights the need for a country to be adaptable and responsive to global economic shifts, regardless of the exchange rate regime they choose. How do you think countries can best prepare for such unpredictable global events?