Economics Q&A: What is a managed floating exchange rate?

A managed currency is an exchange rate that is basically floating in the foreign exchange markets but is subject to intervention from time to time by the monetary authorities, in order to resist fluctuations that they consider to be undesirable. Normally the currency floats freely in the market - the value is determined by the forces of supply and demand for a given currency. But the government and/or central bank of a country may decide to use intervention in the currency market as a way of manipulating its value to achieve given macroeconomic objectives For example an attempt to bring about a depreciation to (i) Improve the balance of trade in goods and services / improve the current account position (ii) Reduce the risk of a deflationary recession - a lower currency increases export demand and increases the domestic price level by making imports more expensive (iii) To rebalance the economy away from domestic consumption towards exports and investment (iv) Selling foreign currencies to overseas investors as a way of reducing the size of government debt Or to bring about an appreciation of the currency (i) To curb demand-pull inflationary pressures (ii) To reduce the price of imported capital and technology When intervening, a central bank can (a) Buy and sell domestic and foreign currencies in the market - for example if the Polish central bank wants to drive the Polish Zloty higher it will sell Euros in the market and buy Zloty in exchange. (b) The central bank may choose instead to change policy interest rates - e.g. raising interest rates in a bid to attract short term inflows of hot money into their domestic banking system from overseas. Although many currencies are officially free-floating it is not difficult to find examples of central bank intervention Poland: The Polish Zloty has floated freely since 2000 but in January 2011 the Polish state-owned BGK bank sold between 1.2 billion and 2 billion of the finance ministrys cash strengthening the zloty and allowing Polands public debt to stay under 55% of gross domestic product at the end of 2010 Chile: The Chilean currency (the peso) has been rising strongly against the US dollar and the Chilean central bank has announced that it plans to buy US dollars totalling $12 billion to weaken the currency, with purchases of $50 million a day from Tuesday through to February 9th 2011. Japan: The Japanese central bank has often intervened in currency markets to manipulate the Yen and try to make Japanese exports more competitive in world markets. It spent more than 2 trillion yen buying foreign currencies in September 2010 to stem a rise in the yen that has hit their export sector and threatened to derail the countrys fragile economic recovery.

Switzerland: The Swiss Franc has been appreciating against the Euro - in part because of investor nervousness about the financial crisis in the Euro Zone. The Swiss Central Bank has intervened on several occasions in the last two years to curb this rise in their currency because they fear a damaging effect on Swiss exports and the risk of price deflation. Brazil: Brazil has seen her currency (the real) soar against the US dollar - in the main because of a flood of cheap cash due to ultra-low policy interest rates and quantitative easing in the USA and other advanced nations. The speculative flow into the Brazilian banking system has driven up the real and prompted fears it could weaken exports and competitiveness and threaten Brazilian growth at a key stage of their development. The Brazilian government claims that it is now involved in a currency war and there has been much coverage in the media about a range of policy interventions designed to stop the real appreciating any further - this includes tightening controls on the free flow of capital into the Brazilian monetary system for example a tax on speculative money that flows in which is simply a bet on the US dollar depreciating. United Kingdom In the UK the Bank of England has not intervened DIRECTLY in the currency markets to influence the external value of the pound. So we can still claim to have a FREE FLOATING exchange rate in practice. That said the depreciation of sterling during 2008-09 was accelerated by the drastic cuts in official policy interest rates in the UK and also by the quantitative easing programme. So perhaps the Governor of the Bank of England Mervyn King has managed to achieve a useful currency depreciation through the back door! Manipulating currencies for macroeconomic reasons is likely to be a hot topic in the next couple of years. There are doubts about the effectiveness of such intervention especially given the scale of foreign currency transactions every minute of the day. But using the exchange rate as a policy lever is something that countries in economic distress may choose to to very seriously as we head through 2011. Managed float regime is the current international financial environment in which exchange rates fluctuate from day to day, but central banks attempt to influence their countries' exchange rates by buying and selling currencies. It is also known as a dirty float. In an increasingly integrated world economy, the currency rates impact any given country's economy through the trade balance. In this aspect, almost all currencies are managed since central banks or Governments intervene to influence the value of their currencies.