The floating exchange rate (also called fluctuating or flexible exchange rate ) is a type of exchange rate regime where currency values ​​are allowed to fluctuate in response to market mechanisms foreign exchange. Currency using floating exchange rate is known as floating currency. Floating currency is contrasted with a fixed currency whose value is tied to other currencies, material goods or to the basket of currencies.
In the modern world, most of the world's currencies are floating; the currency is among the most heavily traded currencies: the United States dollar, the Swiss franc, the Indian rupee, the euro, the Japanese yen, the British pound and the Australian dollar. However, central banks often participate in the market to try to influence floating exchange rates. The Canadian dollar most closely resembles a pure floating currency, because the Canadian central bank does not disrupt prices because it officially ceased to do so in 1998. The US dollar is running a close second, with little change in its foreign exchange reserves; In contrast, Japan and Britain intervened to a greater extent, while India had seen mid-range intervention by its central bank, the Reserve Bank of India.
From 1946 to the early 1970s, the Bretton Woods system made the currency remains the norm; However, in 1971, the US decided no longer to enforce the dollar exchange at 1/35th of an ounce of gold, so the currency was no longer fixed. After the Smithsonian Treaty of 1973, most of the world's currencies followed. However, some countries, like most Gulf countries, assign their currency to the value of other currencies, which are later associated with slower growth rates. When the currency is floating, the target other than the exchange rate itself is used to manage monetary policy (see open market operations).
Video Floating exchange rate
Economic reason
There are economists who think that in most circumstances, a floating exchange rate is preferred over a fixed exchange rate. Since floating rates automatically adjust, they allow a country to reduce the impact of foreign business shocks and cycles, and to precede the possibility of having a balance of payment crisis. However, they also generate uncertainty as a result of their dynamism.
However, in certain situations, a fixed exchange rate may be better for greater stability and certainty. That may not necessarily be true, given the results of countries that are trying to keep their currency prices "strong" or "high" relative to others, such as Britain or Southeast Asian countries before the Asian currency crisis.
The debate makes the choice between a fixed and floating exchange rate regime fixed by the Mundell-Fleming model, which argues that the economy (or government) can not simultaneously maintain a fixed exchange rate, free capital movement, and independent monetary policy. It should choose two to control and leave the other to market forces.
The main argument for a floating exchange rate is to allow a favorable monetary policy for other purposes. Under fixed interest rates, monetary policy is committed to the sole purpose of maintaining exchange rates at an announced rate. However, exchange rates are only one of the many macroeconomic variables that can be affected by monetary policy. A floating exchange rate system makes monetary policy makers free to pursue other goals such as stabilizing jobs or prices.
In the case of extreme appreciation or depreciation, the central bank will usually intervene to stabilize the currency. Thus, the floating currency exchange rate regime may be more technically known as managed float . A central bank may, for example, allow the price of free floating currency between the upper and lower limits, the price of "ceilings" and "floors". Management by the central bank can take the form of buying or selling large lots to provide price or resistance support or, in the case of some national currencies, there may be legal penalties for trading beyond this limit.
Maps Floating exchange rate
Fear floating
A free floating exchange rate increases the volatility of foreign exchange. There are economists who think that this can cause serious problems, especially in developing countries. These countries have a financial sector with one or more of the following conditions:
- dollarize high responsibilities
- financial fragility
- strong balance sheet effect
When liabilities are denominated in foreign currency while assets are in local currency, the unexpected depreciation of exchange rates worsens banks and balance sheets and threatens the stability of the domestic financial system.
For this reason developing countries seem to face greater fear of floating, as they have a much smaller nominal exchange rate variation, but face greater shock and interest rates and reserve movements. This is a consequence of the frequent free-floating state reaction to exchange rate movements with monetary policy and/or intervention in the foreign exchange market.
The number of countries that presented a floating fear increased significantly during the 1990s.
See also
- Fixed exchange rate
- dollarization of domestic responsibilities
- List of countries with floating currency
- Currency appreciation and depreciation
References
Further reading
- Fiscal exchange rate and performance. Does the exchange rate regime produce more discipline than is flexible? VÃÆ'ºletin, Guillermo Javier. April 2002.
Source of the article : Wikipedia
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