Exchange rate regime

The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market. It is closely related to monetary policy 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 euro.

Types

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/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 indicators.
* "Crawling pegs": 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 board 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. ( [http://www.rrz.uni-hamburg.de/RRZ/R.Tiwari/papers/exchange-rate.pdf PDF] )


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