Floating Exchange Rate

• Floating exchange rate is also known as Fluctuating

exchange rate.
• It is a type of exchange rate regime wherein currency’s
value is allowed to fluctuate according to the foreign
exchange market.
• The currency that used in a floating exchange rate is said
to be floating currency.
• Floating exchange rate automatically adjusts, they
enable a country to dampen the impact of shocks and
foreign business cycle.
• So, sometimes it is preferable.
 Floating Exchange Rate

• In floating exchange rates there is hardly any need to maintain

large reserves to develop the economy. These reserves can
therefore be fruitfully used to import capital goods and other
items in order to promote faster economic growth.
• But, in certain situations, due to its greater stability and
certainty, fixed exchange rate may be more preferable.
• An economy cannot simultaneously maintain a fixed exchange
rate, free capital movement and an independent monetary
policy.
• In extreme appreciation or depreciation, a central bank will
normally intervene to stabilize the currency.
• Thus, floating currency’s exchange rate regime may more
technically be known as ‘managed float.’
 Disadvantages of Floating Exchange Rate

• Free floating exchange rate increases foreign exchange volatility.

• It may bring uncertainty in the econmy.
• It sometimes create serious problem in the economy, especially in
emerging economy.
 High liability of dollarization
 Financial fragility
 Strong balance sheet effect.
 Linked Exchange Rate System
• It is a type of exchange rate regime to link (peg) the exchange rate
of a currency to another currency.
• The Linked Exchange Rate system suits the needs of a highly
open economy.
• It is a Currency Board system that requires both the stock and the
flow of the Monetary Base to be fully backed by foreign reserves.
• The expansion or contraction in the Monetary Base causes
interest rates for the domestic currency to fall or rise respectively,
creating the monetary conditions that automatically counteract the
original capital movement, while the exchange rate remains
stable. This process is very much an automatic mechanism.
• Hongkong employed this system to estabilize the exchange rate
between Hongkong dollar and US doller.
• The Macao Pataca is similarly linked to the Hongkong dollar.
• In this system, government or central bank does not actively
interfare in the forex market by controlling supply and
demand of the currency to influence the exchange rate.
• A mechanism is developed and it controls the exchange rate
in this system.
• It helps to remove uncertainty about appreciation potential
of the linked currency.
• It helps to maintain interest rates of linked currency closer
to the other currency’s rates with home the currency is
linked to.
• The linked exchange rate system is a cornerstone for
maintaining economic stability (Hongkong experience).