Floating exchange rate
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A floating exchange rate or a flexible exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating exchange rate is known as a floating currency. The opposite of a floating exchange rate is a fixed exchange rate.
Economists generally think that, in most circumstances, floating exchange rates are preferable to fixed exchange rates because floating rates are responsive to the foreign exchange market. This allows the dampening of shocks and foreign business cycles. However, in certain situations, fixed exchange rates may be preferable for their greater stability and certainty.
There is no currency in the world whose value is absolutely and entirely determined by the foreign exchange market; in cases of extreme appreciation or depreciation, a central bank will normally intervene to stabilize the currency. Thus, the exchange rate regimes of floating currencies may more technically be known as a managed float. A central bank might, for instance, allow a currency price to float freely between an upper and lower bound, a price "ceiling" and "floor". Management by the central bank may take the form of buying or selling large lots in order to provide price support or resistance, or, in the case of some national currencies, there may be legal penalties for trading outside these bounds.
Literature
- Tiwari, Rajnish (2003): Post-Crisis Exchange Rate Regimes in Southeast Asia, Seminar Paper, University of Hamburg. ([PDF])
External links
- [Foreign Market Watch] Analysis and Commentary on the major currency pairs
- [Currency Trading Basics], from OANDA's FXTrade site
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