Forex Floating exchange rate

Document Sample
Forex Floating exchange rate Powered By Docstoc
					Floating exchange rate
A floating exchange rate or fluctuating exchange rate is a type of exchange rate
regime wherein a currency's value is allowed to fluctuate according to the foreign
exchange market. A currency that uses a floating exchange rate is known as a floating

Economic rationale
There are economists who think that, in most circumstances, floating exchange rates
are preferable to fixed exchange rates. As floating exchange rates automatically
adjust, they enable a country to dampen the impact of shocks and foreign business
cycles, and to preempt the possibility of having a balance of payments crisis.

However, in certain situations, fixed exchange rates may be preferable for their
greater stability and certainty. This 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 Asian
currency crisis.

The debate of making a choice between fixed and floating exchange rate regimes is
set forth by the Mundell–Fleming model, which argues that an economy (read:
government) cannot simultaneously maintain a fixed exchange rate, free capital
movement, and an independent monetary policy. It can choose any two for control,
and leave the third to market forces.

The primary argument for a floating exchange rate is that it allows monetary policies
to be useful for other purposes. Under fixed rates monetary policy is committed to the
single goal of maintaining exchange rate at its announced level. Yet the exchange rate
is only one of many macro economic variable that monetary policy can influence. A
system of floating exchange rate leaves monetary policy makers free to pursue other
goals such as stabilizing employment or prices.

In cases of extreme appreciation or depreciation, a central bank will normally
intervene to stabilize the currency. Thus, the exchange rate regimes of floating
currencies may more technically be known as a managed float. A central bank might,
for instance, allow a currency price to float freely between an upper and lower bound,
a price "ceiling" and "floor". Management by the central 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

Floating currency
An ABC news report on the first day of trading with a floating Australian dollar,
See also: List of countries with floating currencies
         This section does not cite any references or sources. (November 2010)

A floating currency is a currency that uses a floating exchange rate as its exchange
rate regime. A floating currency is contrasted with a fixed currency.

In the modern world, the majority of the world's currencies are floating. Central banks
often participate in the markets to attempt to influence exchange rates. Such
currencies include the most widely traded currencies: the United States dollar, the
euro, the Norwegian krone, the Japanese yen, the British pound, the Swiss franc[1] and
the Australian dollar. The Canadian dollar[2] most closely resembles the ideal floating
currency as the Canadian central bank has not interfered with its price since it
officially stopped doing so in 1998.

The US dollar[3] runs a close second with very little changes in its foreign reserves; by
contrast, Japan[4] and the UK[5] intervene to a greater extent. From 1946 to the early
1970s, the Bretton Woods system made fixed currencies the norm; however, in 1971,
the United States government would no longer uphold the dollar exchange at 1/35th
ounce of gold, so that the US dollar was no longer a fixed currency. After the 1973
Smithsonian Agreement most of the world's currencies followed suit.

A floating currency is one where targets other than the exchange rate itself are used to
administer monetary policy. See open market operations.

Fear of floating
        The examples and perspective in this section may not represent a
        worldwide view of the subject. Please improve this article and discuss the
        issue on the talk page. (May 2010)

A free floating exchange rate increases foreign exchange volatility. There are
economists who think that this could cause serious problems, especially in emerging
economies. These economies have a financial sector with one or more of following

      high liability dollarization
      financial fragility
      strong balance sheet effects

When liabilities 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.

For this reason emerging countries appear to face greater fear of floating, as they have
much smaller variations of the nominal exchange rate, yet face bigger shocks and
interest rate and reserve movements.[6] This is the consequence of frequent free
floating countries' reaction to exchange rate movements with monetary policy and/or
intervention in the foreign exchange market.

The number of countries that present fear of floating increased significantly during the

Shared By: