The
exchange rate regime is the way a country manages its
currencyIn economics, the term currency can refer either to a particular currency, for example the US dollar, or to the coins and banknotes of a particular currency, which comprise the physical aspects of a nation's money supply...
in respect to foreign currencies and the
foreign exchange marketThe foreign exchange market trades currencies. It lets banks and other institutions easily buy and sell currencies....
. It is closely related to
monetary policyMonetary policy is the process by which the government, central bank, or monetary authority of a country controls the supply of money, availability of money, and cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy...
and the two are generally dependent on many of the same factors.
The basic types are a
floating exchange rate, where the market dictates the movements of the exchange rate, a
pegged float, where the central bank keeps the rate from deviating too far from a target band or value, and the
fixed exchange rate, which ties the currency to another currency, mostly more widespread currencies such as the U.S.
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The
exchange rate regime is the way a country manages its
currencyIn economics, the term currency can refer either to a particular currency, for example the US dollar, or to the coins and banknotes of a particular currency, which comprise the physical aspects of a nation's money supply...
in respect to foreign currencies and the
foreign exchange marketThe foreign exchange market trades currencies. It lets banks and other institutions easily buy and sell currencies....
. It is closely related to
monetary policyMonetary policy is the process by which the government, central bank, or monetary authority of a country controls the supply of money, availability of money, and cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy...
and the two are generally dependent on many of the same factors.
The basic types are a
floating exchange rate, where the market dictates the movements of the exchange rate, a
pegged float, where the central bank keeps the rate from deviating too far from a target band or value, and the
fixed exchange rate, which ties the currency to another currency, mostly more widespread currencies such as the U.S. dollar or the
euroThe euro is the official currency of 16 of the 27 Member States of the European Union . The states, known collectively as the Eurozone, are Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain...
.
Float
Floating rates are the most common exchange rate regime today. For example, the dollar, euro, yen, and British pound all float. However, since central banks frequently intervene to avoid excessive appreciation or depreciation, these regimes are often called
managed float or a
dirty float.
Pegged float
Here, the currency is pegged to some band or value, either fixed or periodically adjusted. Pegged floats are:
- Crawling bands: the rate is allowed to fluctuate in a band around a central value, which is adjusted periodically. This is done at a preannounced rate or in a controlled way following economic indicator
An economic indicator is a statistic about the economy. Economic indicators allow analysis of economic performance and predictions of future performance....
s.
- Crawling peg
Crawling peg is an exchange rate regime usually seen as a part of fixed exchange rate regimes which allows depreciation or appreciation in an exchange rate gradually...
s: Here, the rate itself is fixed, and adjusted as above.
- Pegged with horizontal bands: The currency is allowed to fluctuate in a fixed band (bigger than 1%) around a central rate.
Fixed
Fixed rates are those that have direct convertibility towards another currency. In case of a separate currency, also known as a
currency boardA currency board is a monetary authority which is required to maintain a fixed exchange rate with a foreign currency. This policy objective requires the conventional objectives of a central bank to be subordinated to the exchange rate target....
arrangement, the domestic currency is backed one to one by foreign reserves. A pegged currency with very small bands (< 1%) and countries that have adopted another country's currency and abandoned its own also fall under this category.
Literature
- Tiwari, Rajnish (2003): Post-Crisis Exchange Rate Regimes in Southeast Asia, Seminar Paper, University of Hamburg. (PDF)