Flexible exchange rate is a system where the value of one currency in terms of another is free to fluctuate and establish the equilibrium level through the forces of demand and supply. It can be better understood with the following merits and demerits of the flexible exchange rate :
(i) Merits :
(1) No need to maintain reserves of foreign currency.
(2) Automatic adjustment in balance of payments (BOP) is possible.
(3) No dependence on external sources
(ii) Demerits :
(1) It creates unstable conditions and uncertainty.
(2) Increased speculation with a destabilizing effect.
(3) Gives rise to inflation in the economy.