The floating exchange rate regime, which is also referred to as the fluctuating exchange rate regime is one of several kinds or regime in which the value of a currency can fluctuate according to movement of the foreign exchange market. For any currency within this particular system, it is called a “floating currency”. Keep in mind that in developing countries, it is impossible for their currency’s exchange rate to maintain stability within the foreign exchange market. In this case, rather than use the floating exchange rate regime, these countries would choose one of the two options listed below:
1. The exchange rate would be allowed to fluctuate within an open market based on current market conditions
2. As a means of maintaining equilibrium, it might be fixed so it could be adopted, using a number of attempts. However, in situations of fundamental change, the exchange rate for that country’s currency should change in line with this change.
Some financial experts believe that the floating exchange rate regime is the more appropriate choice to use because it does not interfere with foreign trade. In fact, some economy experts strongly believe that floating exchange rates are the better choice over fixed exchange rates in most circumstances. For one thing, using the floating exchange rate regime, adjustments are made automatically. Using floating exchange rates also makes it possible for countries to lessen shocks, as well as cycles for foreign business. In addition, the floating exchange rate regime can eliminate the possibility of a country experiencing any type of crisis for balance of payments.
While in most cases the floating exchange rate regime is the preferred choice, remember that some circumstances do better with a fixed exchange rate. The reason is that for some situations, the fixed exchange rate provides more certainty and stability. However, some experts believe that for countries attempting to keep currency prices strong in connection to other currency, the fixed exchange may not be the right choice.
As an example, when looking at one of the models forecasters used called the Mundell-Fleming Model, it shows that an economy cannot maintain the fixed exchange rate, independent monetary policy, and free capital movement at the same time. Instead, two factors would be chosen while allowing the third to move according to market forces. This is one reason that economists use different models depending on the currency and factors involved so it could be determined if a fixed exchange rate or floating exchange rate regime makes more sense.
Of course, any time there is a situation of extreme appreciation or depreciation, one of the central banks would step in to help stabilize the currency involved. This is why sometimes the floating exchange rate is called the “managed float”. As an example, the intervening bank may determine that a country can let the currency price float between and upper and lower level or the bank may get involved with buying and selling large quantities to help support or resist currency price.
Related posts: