Exchange rate regime
Encyclopedia
The exchange-rate regime is the way a country manages its currency
in relation to other 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 movements in the exchange rate; a pegged float, where a central bank keeps the rate from deviating too far from a target band or value; and a fixed exchange rate
, which ties the currency to another currency, mostly more widespread currencies such as the U.S. dollar or the euro
or a basket of currencies.
or a dirty float
.
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.
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
in relation to other currencies and the foreign exchange market
Foreign exchange market
The foreign exchange market is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends...
. It is closely related to monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
and the two are generally dependent on many of the same factors.
The basic types are a floating exchange rate, where the market dictates movements in the exchange rate; a pegged float, where a central bank keeps the rate from deviating too far from a target band or value; and a fixed exchange rate
Fixed exchange rate system
A fixed exchange-rate system is a currency system in which governments try to keep the value of their currencies constant against one another....
, which ties the currency to another currency, mostly more widespread currencies such as the U.S. dollar or the euro
Euro
The euro is the official currency of the eurozone: 17 of the 27 member states of the European Union. It is also the currency used by the Institutions of the European Union. The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,...
or a basket of currencies.
Types
Float
Floating rates are the most common exchange rate regime today. For example, the dollar, euro, yen, and British pound all are floating currencies. However, since central banks frequently intervene to avoid excessive appreciation or depreciation, these regimes are often called managed floatManaged float regime
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...
or a dirty float
Managed float regime
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...
.
Pegged float
Pegged floating currencies are pegged to some band or value, either fixed or periodically adjusted. Pegged floats are:- Crawling bands: the rate is allowed to fluctuate in a bandBand of fluctuationBand of fluctuation is the range within which the market value of a national currency is permitted to fluctuate by international agreements, or by unilateral decision by the central bank....
around a central value, which is adjusted periodically. This is done at a preannounced rate or in a controlled way following economic indicatorEconomic indicatorAn economic indicator is a statistic about the economy. Economic indicators allow analysis of economic performance and predictions of future performance. One application of economic indicators is the study of business cycles....
s. - Crawling pegCrawling pegCrawling 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 ratesFixed exchange rate system
A fixed exchange-rate system is a currency system in which governments try to keep the value of their currencies constant against one another....
are those that have direct convertibility towards another currency. In case of a separate currency, also known as a currency board
Currency board
A 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.
Dollarization
Dollarization occurs when the inhabitants of a country use foreign currency in parallel to or instead of the domestic currency. The term is not only applied to usage of the United States dollar, but generally to the use of any foreign currency as the national currency.Literature
- Edwards, Sebastian & Levy Yeyati, Eduardo (2003) "Flexible Exchange Rates as Shock Absorbers," NBER Working Papers 9867, National Bureau of Economic Research, Inc. (http://ideas.repec.org/p/nbr/nberwo/9867.html).
- Kiguel, Andrea & Levy Yeyati, Eduardo (2009) "Back to 2007: Fear of appreciation in emerging economies" (http://www.voxeu.org/index.php?q=node/3917).
- Tiwari, Rajnish (2003): Post-Crisis Exchange Rate Regimes in Southeast Asia, Seminar Paper, University of Hamburg. (PDF)
- Levy-Yeyati, Eduardo & Sturzenegger, Federico & Reggio, Iliana (2006) "On the Endogeneity of Exchange Rate Regimes," Working Paper Series rwp06-047, Harvard University, John F. Kennedy School of Government. (http://ideas.repec.org/p/ecl/harjfk/rwp06-047.html)
- Nenovsky. N, K. Dimitrova(2006). Rate and Inflation: France and Bulgaria in the interwar period“.International Center for Economic Research Working Paper, Torino, No 34, 2006
- Nenovsky. N, G. Pavanelli and Dimitrova, K(2007). Rate Control in Italy and Bulgaria in the Interwar Period: History and Prospectives“.International Center of Economic Research Working Paper,Torino, No 40, 2007
- Roberto Frenkel and Martín Rapetti, A Concise History of Exchange Rate Regimes in Latin America, Center for Economic and Policy ResearchCenter for Economic and Policy ResearchThe Center for Economic and Policy Research is a progressive economic policy think-tank based in Washington, DC, founded in 1999. CEPR works on Social Security, the US housing bubble, developing country economies , and gaps in the social policy fabric of the US economy.According to its own...
, April 2010