What Is A Managed Floating Exchange Rate
Uploaded by
KrithikaVenkatWhat Is A Managed Floating Exchange Rate
Uploaded by
KrithikaVenkatWhat is a managed floating exchange rate?
A managed currency is an exchange rate that is basically floating in the foreign exchange markets
but is subject to intervention from time to time by the monetary authorities, in order to resist
fluctuations that they consider to be undesirable.
Normally the currency floats freely in the market - the value is determined by the forces of supply
and demand for a given currency.
But the government and/or central bank of a country may decide to use intervention in the currency
market as a way of manipulating its value to achieve given macroeconomic objectives
For example an attempt to bring about a depreciation to
(i) Improve the balance of trade in goods and services / improve the current account position
(ii) Reduce the risk of a deflationary recession - a lower currency increases export demand and
increases the domestic price level by making imports more expensive
(iii) To rebalance the economy away from domestic consumption towards exports and investment
(iv) Selling foreign currencies to overseas investors as a way of reducing the size of government
debt
Or to bring about an appreciation of the currency
(i) To curb demand-pull inflationary pressures
(ii) To reduce the price of imported capital and technology
Fixed Exchange Rate:
Under fixed rate regime, Government fixes the rate of exchange at which foreign currencies can be
bought and sold. Exchange rate is fixed with respect to value of gold per ounce or with respect to
dollar or pounds. Once exchange rate is fixed, supply and demand of foreign exchange is regulated
by central bank of the country.
Floating Exchange Rate:
Under this system, Government fixes the range of foreign exchange rate within which foreign
exchange is allowed to fluctuate according to the demand and supply of foreign currency in the
market.
For example, if rate of exchange of Rupee and Dollar is Rs. 50=1 $ and Government decides to
allow 10% margin, then till the rate does not exceed Rs. 55 or fall below Rs. 45, central bank is not
allowed to intervene in the foreign exchange market. Rate of exchange is allowed to fluctuate
between Rs. 55 to Rs. 45 per dollar.
If the rate moves above Rs. 55, central bank will intervene by supplying dollars in the market till
exchange rate falls below Rs. 55. If the rate falls below Rs. 45, then central bank will buy dollar from
the market till exchange rate rises above Rs. 45.
This type of exchange rate mechanism is very useful as it provides the benefit of fixed exchange rate
and flexible exchange rate.