Economics
Study Notes
Managed Floating Exchange Rates
- Level:
- A Level, IB
- Board:
- AQA, Edexcel, OCR, IB, Eduqas, WJEC
Last updated 5 Apr 2021
In this revision video we focus on the economics of managed floating exchange rates.
A managed floating exchange rate is an exchange rate system that allows a nation’s central bank to intervene regularly in foreign exchange markets to change the direction of the currency’s float and/or reduce the amount of currency volatility. This exchange rate system is also known as a “dirty float”.
Motivations for managing a floating currency through intervention
Central bank might attempt to bring about a depreciation to:
- Improve the balance of trade or improve the current account by making exports more price competitive
- Reduce the risk of a deflationary recession - a lower currency increases export demand and increases the domestic price level by making imports more expensive
- Rebalance the economy away from consumption towards higher exports and capital investment
Or to bring about an appreciation of the currency
- To curb demand-pull inflationary pressures
- To reduce the prices of imported capital and technology or essential inputs to enhance long run growth potential
Limits to central bank intervention to manage a currency’s value
- Requires large-scale foreign exchange reserves – many smaller and relatively poorer countries do not have these
- Central banks intervening on their own may have little or no market power against the sheer weight of speculative buying and selling in global currency markets (turnover > $6 trillion a day)
- Changing interest rates to influence a currency might conflict against other macroeconomic objectives - raising interest rates to support a currency might stifle growth
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