8/2/2019 A Floating Exchange Rate or Fluctuating Exchange Rate is a Type of Exchange Rate Regime Wherein a Currency

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A floating exchange rate or fluctuating exchange rate is a type ofexchange rate regimewherein

acurrency's value is allowed to fluctuate according to theforeign exchange market. A currency

that uses a floating exchange rate is known as afloating currency. It is not possible for a

developing country to maintain the stability in the rate of exchange for its currency in the

exchange market.

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There areeconomistswho think that, in most circumstances, floating exchange rates are

preferable to fixed exchange rates. As floating exchange rates automatically adjust, they enable a

country to dampen the impact ofshocksand foreignbusiness cycles, and to preempt the

possibility of having a balance of payments crisis. However, in certain situations, fixed exchange

rates may be preferable for their greater stability and certainty. This may not necessarily be true,

considering the results of countries that attempt to keep the prices of their currency "strong" or

"high" relative to others, such as the UK or the Southeast Asia countries before theAsian

currency crisis. The debate of making a choice between fixed and floating exchange rate regimes

is set forth by theMundell-Fleming model, which argues that an economy cannot simultaneously

maintain a fixed exchange rate, free capital movement, and an independent monetary policy. It

can choose any two for control, and leave third to the market forces.

In cases of extreme appreciation or depreciation, acentral bankwill 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.

[edit] Fear of floating

The examples and perspective in this section may not represent aworldwide viewof the

subject. Pleaseimprove this articleand discuss the issue on thetalk page.

A free floating exchange rate increases foreign exchange volatility. There are economists who

think that this could cause serious problems, especially in emerging economies. These economies

have a financial sector with one or more of following conditions:

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high liability dollarization

financial fragility

strong balance sheet effects

Whenliabilitiesare denominated in foreign currencies while assets are in the local currency,

unexpected depreciations of the exchange rate deteriorate bank and corporate balance sheets andthreaten the stability of the domestic financial system.

For this reason emerging countries appear to face greater fear of floating, as they have much

smaller variations of the nominal exchange rate, yet face bigger shocks and interest rate and

reserve movements.[1]

This is the consequence of frequent free floating countries' reaction to

exchange rate movements withmonetary policyand/or intervention in theforeign exchange

market.

The number of countries that present fear of floating increased significantly during the nineties.[2]

[edit] References

1. ^Calvo, G., and Reinhart, C. (2002). "Fear of Floating." Quarterly Journal of Economics, 117:379-408.

2. ^Levy-Yeyati, E. and F. Sturzenegger (2004). "Classifying Exchange Rate Regimes: Deeds vs.Words." European Economic Review.

Retrieved from "http://en.wikipedia.org/wiki/Floating_exchange_rate"

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