Floating exchange rate

A floating exchange rate (also called a fluctuating or flexible 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 events. 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, material goods or to a currency basket. In the modern world, most of the world's currencies are floating; they include the most widely-traded currencies: the United States dollar, the Swiss franc, the Indian rupee, the euro, 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, and India has seen medium-range intervention by its central bank, the Reserve Bank of India. From 1946 to the early 1970s, the Bretton Woods system made fixed currencies the norm; however, in 1971, the US decided no longer to uphold the dollar exchange at 1/35th of an ounce of gold and so its currency was no longer fixed. After the 1973 Smithsonian Agreement, most of the world's currencies followed suit. However, some countries, such as most of the Gulf States, fixed their currency to the value of another currency, which has been more recently associated with slower rates of growth. When a currency floats, targets other than the exchange rate itself are used to administer monetary policy (see open-market operations). Some economists 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 of shocks and foreign business cycles and to preempt the possibility of having a balance of payments crisis. However, they also engender unpredictability as the result of their dynamism, which can render businesses' planning risky since the future exchange rates during their planning cycle are uncertain. However, in certain situations, fixed exchange rates may be preferable for their greater stability and certainty. That 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 the Asian currency crisis. The debate of making a choice between fixed and floating exchange rate regimes is set forth by the Mundell–Fleming model, which argues that an economy (or the government) cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. It must choose any two for control and leave the other to market forces.