MANAGED EXCHANGE RATES

A managed-exchange-rate system is a hybrid or mixture of the fixed and flexible exchange rate systems in which the government of the economy attempts to affect the exchange rate directly by buying or selling foreign currencies or indirectly, through monetary policy6 (i.e., by lowering or raising interest rates on foreign currency bank accounts, affecting foreign investment, etc.).

Today, most of the economies have shifted to this system of exchange rate determination. Almost all countries tend to intervene when the markets become disorderly or the fundamentals of economics are challenged by the exchange rate of the time. Some of the major examples of the managed exchange-rate system have been given below:7

(i) Some countries allow to free float their currencies and allow the market forces to determine their exchange rate with rare government intervention. This is the idea from which the floating currency regime basically emerged. The USA and the EU are the major examples in this category.

(ii) Some economies have managed but flexible exchange rates, under which the governments buy or sell its currency to reduce day-to-day volatility of currency fluctuations and sometimes go for systematic intervention for desired objectives. Canada and Japan fall in this category, besides many developing countries. India too falls under this category which follows the dual currency regime since 1992–93 financial year.8

(iii) Some economies, particularly small ones, peg their currencies to a major currency or to a basket of currency in a fixed exchange rate— known as the pegging of currencies. At times, the peg is allowed to glide smoothly upward or downward—a system which is known as gliding or crawling peg. Some economies have a hard fix of a currency board. A currency board is working well in Hong Kong while the same failed in Argentina in 2002.