Floating Currency Exchange Rate

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Floating Exchange Rate Definition

Free floating or Clean floating of a currency occurs when its exchange rates are left free to be determined by the market forces of demand for and supply of that currency in foreign exchange market with no floor or ceiling vis-à-vis the dollar, gold, SDRs, or any other currency. The government does not intervene directly or indirectly in this market, nor does it needs to hold large reserves for supporting the currency. the principle advantage of the a system of free floating is that it avoids the problems of financing balance of payment disequilibria inherent in a fixed exchange rate system.

Manages Floating Exchange Rate

it occurs when the currency is not allowed to float freely but is manages in a desired direction by central bank intervention. Such intervention is usually undertaken to prevent fluctuations in exchange rates or to encourage a movement towards a rate conductive to balance of payment equilibrium in the medium term. it is sometimes termed a “dirty” float implying manipulation to influence the currency rate artificially.

Dirty Float

What Is a Dirty Float? Dirty Float is a floating exchange rate where Central bank intervening in the free market even though their declared policy is “flexible”. the intervention is aimed at reducing short-run exchange rate uncertainty but allowing the exchange rate to vary based on interest rate differential and other fundamentals.

Wide Band Exchange Rate System

Allowing exchange rate to vary within a wider band. This practice was adopted after December 1971 when IMF agreed to allow fluctuation of exchange rates to 2.25% on either side before the central bank would intervene.

Crawling Peg / Crawling band Exchange Rate System

A system whereby the par value is automatically revised. this system requires the central bank to intervene whenever the exchange rate approaches a support point. the Par Value/ Central Value is revised based on average exchange rates over the previous Week/Month.

Floating Exchange Rate Example

For example, one U.S. dollar might buy one Euro today, but it might only buy 0.98 Euro tomorrow

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