A fixed exchange rate system is a monetary arrangement where a country's currency value is tied or pegged to another major currency, such as the U.S. dollar or Euro. This means that the government or central bank maintains the currency's value within a narrow band, providing stability in international trade and investment. In this system, the central bank intervenes in the foreign exchange market to maintain the fixed rate by buying or selling its currency as needed. While this can help reduce exchange rate volatility, it may limit a country's ability to respond to economic changes, as it must prioritize maintaining the fixed rate over other economic policies.