Floating Exchange Rate
Candlefocus EditorThe primary feature of a floating exchange rate is that the rate of exchange is determined by the market forces of demand and supply without any direct government intervention. In other words, the rate is determined by the relationship between the supply of and demand for the currency in question. If a currency becomes stronger due to higher demand, the exchange rate will go up. Conversely, if the demand declines, the exchange rate will go down.
When countries peg their exchange rate to the U.S. dollar, it is an example of a fixed exchange rate. Under this system, the exchange rates for that country’s currency are determined by the U.S. government, and any fluctuations in the exchange rate are generally limited. However, this exchange rate can become unstable when the government needs to intervene to maintain the rate, usually due to increasing demand or decreasing supply.
By contrast, a floating exchange rate is arguably much more desirable. In addition to allowing currencies to adjust more flexibly to changes in demand and supply, this system provides greater certainty for foreign trade, since countries do not have to constantly adjust their exchange rates. A floating exchange rate also helps keep the price of imported goods lower, since fluctuations in exchange rates can lead to large fluctuations in the prices of imported goods.
Floating exchange rates became more popular after the collapse of the gold standard and the Bretton Woods Agreement in the 1970s. The Agreement was a system of fixed exchange rates among major industrial countries, and its collapse represented a major change in the global economic landscape. This change led to the development of more flexible economic policies and the rise in popularity of the floating exchange rate system.
In conclusion, a floating exchange rate is a type of exchange rate regime where the value of a currency is determined by the free market forces of supply and demand. This system can be beneficial for foreign trade, since it provides greater certainty; however there are potential drawbacks, such as the potential for extreme exchange rate fluctuations. Nonetheless, the floating exchange rate has become increasingly popular since the collapse of the Bretton Woods Agreement.