Foreign Exchange

Floating Exchange Rate Regime

• A floating exchange rate or fluctuating exchange rate is a type of exchange-rate regime in which a currency's value is allowed to fluctuate in response to foreign-exchange market mechanisms.
• A currency that uses a floating exchange rate is known as a floating currency.
• A floating currency is contrasted with a fixed currency whose value is tied to that of another currency, gold or to a currency basket.

• In the modern world, most of the world's currencies are floating; such currencies include the most widely traded currencies: the United States dollar, the euro, the Norwegian krone, the Japanese yen, the British pound, and the Australian dollar.
• However, central banks often participate in the markets to attempt to influence the value of floating exchange rates. The Canadian dollar most closely resembles a "pure" floating currency, because the Canadian central bank has not interfered with its price since it officially stopped doing so in 1998. The US dollar runs a close second, with very little change in its foreign reserves; in contrast, Japan and the UK intervene to a greater extent.

• System in which a currency's value is determined solely by the interplay of the market forces of demand and supply, instead of by government intervention.
• However, all central banks do try to defend these rates within a certain range by buying or selling their country's currency as the situation warrants.

• Unlike the fixed rate, a floating exchange rate is determined by the private market through supply and demand.
• A floating rate is often termed "self-correcting," as any differences in supply and demand will automatically be corrected in the market.
• Look at this simplified model: if demand for a currency is low, its value will decrease, thus making imported goods more expensive and stimulating demand for local goods and services. This in turn will generate more jobs, causing an auto-correction in the market. A floating exchange rate is constantly changing.
• In a floating regime, the central bank may also intervene when it is necessary to ensure stability and to avoid inflation. However, it is less often that the central bank of a floating regime will interfere.

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