Exchange Rate Regime

When talking about the exchange rate regime, this refers to a method used by countries for managing its currency specific to foreign currencies, as well as the actual foreign exchange rate market.  In addition, the exchange rate regime has a close connection to monetary policy.  In fact, both of these dynamics have a close tie.

Exchange rate regime is found in several different types, which includes floating rate, pegged float, and fixed rate.  While these types of exchange rate regime are the most common, keep in mind that others exist.

•    Floating Exchange Rate – With a floating exchange rate, movement of the rate is determined by what the market does.  Of all exchange rate regime used today, the floating method is the most preferred.  Four of the most traded or exchanged currencies in the world include the Euro, US Dollar, Yen, and British Pound, which are all floating rates.  Remember since it is common for central banks to get involved with this method so excessive depreciation or appreciation is avoided.  When this occurs, it is called a “dirty float” or “managed float”.

•    Pegged Float Rate – In the case for the pegged float, the rate is kept from going too far off course regarding value because of management by the central bank. For this exchange rate regime, pegging occurs fixed or periodically adjusted.  The floats associated with this rate include the following:

o    Crawling Bands – For this rate, fluctuations are permitted in a band around a central value, one that would be periodically adjusted.  The way this is accomplished with a preannounced rate or using economic indicated that provides control.
o    Crawling Pegs – For this pegged float method, the rate itself is fixed or adjusted periodically.
o    Pegged with Horizontal Bands – The last method for the pegged exchange rate regime allows currency to fluctuate but with a fixed band around a central rate and one that is greater than 1%.

•    Fixed Exchange Rate – With the fixed exchange rate, one currency is linked to another currency, which could be any two although the most common include the European Euro and the United States Dollar.  In other words, these rates have direct convertibility with another currency.  If a separate currency were involved, which is called a currency board arrangement the domestic currency would have backing one-to-one using foreign reserves.  In other words, these rates have direct convertibility with another currency.  If a separate currency were involved, the domestic currency would have backing one-to-one using foreign reserves.  These bands are typically quite small or less than 1% and usually associated with countries using currency from another country and leaving theirs to sit within this category.

To learn more about exchange rate regime many excellent publications are available online.  Because each of these methods is different and offers unique benefits, it is important for anyone involved with the foreign exchange rate to understand all the details involving the exchange rate regime.