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Exchange Rate Systems

In theory, exchange rates are either fixed or floating.

Fixed exchange rates imply that a country identifies another currency at which it will guarantee a specified exchange rate. It will then take direct and indirect measures to ensure that the market exchange rate equals the fixed exchange rate.

Floating exchange rates imply that a country lets the market determine the exchange rate, and it does not intervene to determine some specified rate.

You should be familiar with the advantages and disadvantages of each system.

In reality, different countries have policies which are usually a mixture of each system. The different classifications are described below:

 

Type

Explanation

Hard Pegs

No separate legal tender

These countries do not have or use their own currencies; they rely exclusively on currencies of other countries for their own use. (Note: this does not include countries that use a shared currency, e.g. The Eurozone)

Some countries have an explicit

Currency Board

These countries have an explicit legal obligation to exchange domestic currency at a specified fixed exchange rate

Soft Pegs

Conventional Pegs and ‘Stabilised Arrangements’

Countries identify a currency or basket of currencies to which they are fixed. It is the policy of their central bank to ensure that these rates are achieved, through use of direct methods (e.g. using foreign reserves) or indirect methods (e.g. changing interest rates or imposing foreign exchange restrictions). Exchange rates must be within 1%-2% of their stated targets.

Crawling pegs and crawl-like arrangements

“Dirty Float”

A country’s currency is adjusted in small amounts at a fixed rate in response to changes in certain indicators. These indicators can either be backward-looking (e.g. inflation-adjusted) or forward-looking(e.g. by looking at projected growth rates). Some arrangements agree that the exchange rate will change based on a determined rate of growth.

Pegged Exchange Rate Within Horizontal Bands

Exchange rates are set between fixed bands around a target. For example: the ERM (of which Sterling fell out on 16 September 1992)

Floating

 

Floating

A floating exchange rate is market determined without a set path for the rate. Intervention can occur in extreme circumstances in order to prevent major shocks, but there are no policies that target a specific level of exchange rate

Free floating

The most free-market exchange rate system. Intervention occurs only in exceptional circumstances.

 

Task: Find as much information as you can on the following currencies and place them into the appropriate category of exchange rate management.

You may wish to find:

Currencies:

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