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''De facto'' exchange-rate arrangements in 2013 as classified by the International Monetary Fund. In
macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes a ...
and
economic policy The economic policy of governments covers the systems for setting levels of taxation, government budgets, the money supply and interest rates as well as the labour market, national ownership, and many other areas of government interventions in ...
, a floating exchange rate (also known as a fluctuating or flexible exchange rate) is a type of
exchange rate regime An exchange rate regime is the way a monetary authority of a country or currency union manages the currency in relation to other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent ...
in which a
currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" in the most specific sense is money in any form when in use or circulation as a medium of exchange, especially circulating banknotes and coins. ...
's value is allowed to fluctuate in response to
foreign exchange market The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all aspects of ...
events. A currency that uses a floating exchange rate is known as a ''floating currency'', in contrast to a ''
fixed currency A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another ...
'', the value of which is instead specified in terms of material
goods In economics, goods are items that satisfy human wants and provide utility, for example, to a consumer making a purchase of a satisfying product. A common distinction is made between goods which are transferable, and services, which are not trans ...
, another currency, or a set of currencies (the idea of the last being to reduce currency fluctuations). In the modern world, most of the world's currencies are floating, and include the most widely traded currencies: the
United States dollar The United States dollar (symbol: ; code: USD; also abbreviated US$ or U.S. Dollar, to distinguish it from other dollar-denominated currencies; referred to as the dollar, U.S. dollar, American dollar, or colloquial buck) is the official curren ...
, the
euro The euro (symbol: €; code: EUR) is the official currency of 19 of the member states of the European Union. This group of states is known as the eurozone or euro area and includes about 343 million citizens . The euro, which is divided ...
, the
Swiss franc#REDIRECT Swiss franc#REDIRECT Swiss franc {{Redirect category shell, 1= {{R from other capitalisation ...
{{Redirect category shell, 1= {{R from other capitalisation ...
, the
Indian rupee The Indian rupee (sign: ₹; currency code: INR) is the official currency of India. The rupee is subdivided into 100 ''paise'' (singular: ''paisa''), though as of 2019, coins of denomination of 1 rupee is the lowest value in use. The issuance ...
, the
pound sterling#REDIRECT Pound sterling#REDIRECT Pound sterling {{Redirect category shell, 1= {{R from other capitalisation ...
{{Redirect category shell, 1= {{R from other capitalisation ...
, the
Japanese yen#REDIRECT Japanese yen#REDIRECT Japanese yen {{R from other capitalisation ...
{{R from other capitalisation ...
, and the
Australian dollar The Australian dollar (sign: $; code: AUD) is the currency of Australia, including its external territories: Christmas Island, Cocos (Keeling) Islands, and Norfolk Island. It is officially used as currency by three independent Pacific Island s ...
. However, even with floating currencies,
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a state or formal monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central ...
s often participate in markets to attempt to influence the value of floating exchange rates. The
Canadian dollar The Canadian dollar (symbol: $; code: CAD; french: dollar canadien) is the currency of Canada. It is abbreviated with the dollar sign $, or sometimes CA$, Can$ or C$ to distinguish it from other dollar-denominated currencies. It is divided int ...
most closely resembles a pure floating currency because the
Canadian national bank
Canadian national bank
has not interfered with its price since it officially stopped doing so during 1998. The US dollar is a close second, with very little change of its
foreign reserves Foreign exchange reserves (also called forex reserves or FX reserves) are cash and other reserve assets such as gold held by a central bank or other monetary authority that are primarily available to balance payments of the country, influence th ...
. By contrast, Japan and the UK intervene to a greater extent, and India has medium-range intervention by its national bank, the
Reserve Bank of India The Reserve Bank of India (RBI) is India's central bank and regulatory body under the jurisdiction of Ministry of Finance , Government of India. It is responsible for the issue and supply of the Indian rupee and the regulation of the Indian bank ...

Reserve Bank of India
. From 1946 to the early 1970s, the
Bretton Woods system The Bretton Woods system of monetary management established the rules for commercial and financial relations among the United States, Canada, Western European countries, Australia, and Japan after the 1944 Bretton Woods Agreement. The Bretton Wo ...
made fixed currencies the norm; however, during 1971, the US government decided to discontinue maintaining the dollar exchange at 1/35 of an ounce of gold and so its currency was no longer fixed. After the end of the
Smithsonian Agreement The Smithsonian Agreement, announced in December 1971, created a new dollar standard, whereby the currencies of a number of industrialized states were pegged to the US dollar. These currencies were allowed to fluctuate by 2.25% against the dollar. ...
in 1973, most of the world's currencies followed suit. However, some countries, such as most of the
Arab states of the Persian Gulf#REDIRECT Arab states of the Persian Gulf#REDIRECT Arab states of the Persian Gulf {{R from move ...
{{R from move ...
region, fixed their currency to the value of another currency, which has been associated more recently with slower rates of growth. When a currency floats, quantities other than the exchange rate itself are used to administer
monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often as ...
(see
open-market operation An open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can either buy or sell government bonds in the open market (this is where the name ...
s).


Economic rationale

Some economists believe that in most circumstances, floating exchange rates are preferable to
fixed exchange rate A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another ...
s. As floating exchange rates adjust automatically, they enable a country to dampen the effect of shocks and foreign
business cycles The business cycle, also known as the economic cycle or trade cycle, are the fluctuations of gross domestic product (GDP) around its long-term growth trend. The length of a business cycle is the period of time containing a single boom and contract ...
and to preempt the possibility of having a
balance of payments crisisA currency crisis is a situation in which serious doubt exists as to whether a country's central bank has sufficient foreign exchange reserves to maintain the country's fixed exchange rate. The crisis is often accompanied by a speculative attack in t ...
. However, they also engender unpredictability as the result of their variability, which can render businesses' planning risky since the future exchange rates during their planning periods are uncertain. However, in certain situations, fixed exchange rates may be preferable for their greater stability and certainty. That may not necessarily be true, considering the results of countries that attempt to keep the prices of their currency "strong" or "high" relative to others, such as the UK, or the Southeast Asia countries before the
1997 Asian financial crisis The Asian financial crisis was a period of financial crisis that gripped much of East Asia and Southeast Asia beginning in July 1997 and raised fears of a worldwide economic meltdown due to financial contagion. The crisis started in Thailand (kno ...
. The debate of choosing between fixed and floating exchange rate methods is formalized by the
Mundell–Fleming model The Mundell–Fleming model, also known as the IS-LM-BoP model (or IS-LM-BP model), is an economic model first set forth (independently) by Robert Mundell and Marcus Fleming. Reprinted in Reprinted in The model is an extension of the IS–LM mode ...
, which argues that an economy (or the government) cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. It must choose any two for control and leave the other to market forces. The primary argument for a floating exchange rate is that it allows monetary policies to be useful for other purposes. Using fixed rates, monetary policy is committed to the single goal of maintaining the exchange rate at its announced level. However, the exchange rate is only one of the many macroeconomic variables that monetary policy can influence. A system of floating exchange rates leaves monetary policymakers free to pursue other goals, such as stabilizing employment or prices. During an extreme appreciation or
depreciation In accountancy, depreciation refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wears, and second, the allocation in ac ...
of currency, a
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a state or formal monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central ...
will normally intervene to stabilize the currency. Thus, the exchange rate methods of floating currencies may more technically be known as managed float. A national bank might, for instance, allow a currency price to float freely between an upper and lower bound, a price "ceiling" and "floor". Management by a national bank may take the form of buying or selling large lots in order to provide price support or resistance or, in the case of some national currencies, there may be legal penalties for trading outside these bounds.


Aversion to floating

A free floating exchange rate increases foreign exchange volatility. Some economists believe that this could cause serious problems, especially in developing economies. Those economies have a financial sector with one or more of following conditions: * high liability dollarization * financial fragility * strong balance sheet effects When
liabilities Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, retail ...
are denominated in foreign currencies while assets are in the local currency, unexpected depreciations of the exchange rate deteriorate bank and corporate balance sheets and threaten the stability of the domestic financial system. Therefore, developing countries seem to have greater aversion to floating, as they have much smaller variations of the nominal exchange rate but experience greater shocks and interest rate and reserve changes. This is the consequence of frequent free floating countries' reaction to exchange rate changes with
monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often as ...
and/or intervention in the foreign exchange market. The number of countries that show aversion to floating increased significantly during the 1990s.


See also

*
Domestic liability dollarizationDomestic liability dollarization (DLD) refers to the denomination of banking system deposits and lending in a currency other than that of the country in which they are held. DLD does not refer exclusively to denomination in US dollars, as DLD encompa ...
* List of countries with floating currencies *
Currency appreciation and depreciation Currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system in which no official currency value is maintained. Currency appreciation ...


References


Further reading


Exchange rate and fiscal performance. Do fixed exchange rate regimes generate more discipline than flexible ones?
Vúletin, Guillermo Javier. April 2002. {{DEFAULTSORT:Floating Exchange Rate Foreign exchange market