Distinguish between a fixed and a managed floating exchange rate system

Floating exchange rates

When a country uses a floating exchange rate system:

* The value of the currency is determined purely by demand and supply of the currency
* Trade flows and capital flows affect the exchange rate under a floating system
* There is no target for the exchange rate and no intervention in the market by the central bank

Sterling has floated since the UK suspended membership of the ERM in September 1992. The Bank of England has not intervened to influence the pound’s
value since it became independent.

Managed floating exchange rate

When a country uses a managed floating exchange rate system

* The value of a currency from day to day is determined by market demand for and supply of the currency
* Some currency market intervention might be considered as part of demand management (e.g. a desire for a slightly lower currency to boost export demand)
* Intervention can either be explicit i.e. a central bank buys foreign currency when it wants the domestic currency to depreciate
* Intervention might come from changes in policy interest rates so as to affect the net flows of short term banking money (so-called “hot money”)
* Verbal intervention is when a central bank tries to send a signal to the currency markets that it wishes the currency to move in a certain direction and that it stands by ready to engage in official market intervention if this does not happen

In 2012 a growing number of countries are moving towards managed or “dirty” floating systems. Brazil, Japan, Switzerland and Norway have all intervened in the currency markets in recent months.

Brazil in particular has claimed that developed nations are seeking to undervalue their currencies to create a competitive advantage in the world economy and kick-start their economies. They have introduced extra taxes on the interest paid on foreign deposits in their banking system.

Competitive devaluations

Competitive devaluations occur when a country deliberately intervenes in foreign exchange markets to drive down the value of their currency to provide a competitive boost to demand and jobs in their export industries. They may also try to do this when faced with the threats of a deflationary recession. Another reason is to entice extra foreign investment into a currency

For nations with persistent trade deficits and rising unemployment a competitive devaluation of the exchange rate can become an attractive option - but there are risks. One is that devaluing an exchange rate can be seen by other countries as a form of trade (or crisis) protectionism that invites some form of retaliatory action. Cutting the exchange rate makes it harder for other countries to export their goods and services hitting their circular flow.

CPD courses

Economics Teachers National Conference 2015

Our popular Economics Teacher National Conference takes place on Monday 22 June 2015 at the superb Wellcome Collection Auditorium on Euston Road in Central London. This is the leading enrichment CPD event for Economics teachers in the UK and always attracts a good number of teaching colleagues from further afield too!Confirmed speaker line-up:Duncan Weldon - BBC Newsnight Economics Correspondent (Economic Policy after the Election)Sir Paul Collier, Oxford University - Where next for Development Economics?Adrian Woolridge (The Economist) - The Great DisruptionDavid Smith (Economics Editor of the Sunday Times) Prospects for the UK EconomyOur delegate prices are:Single Delegate - £175 per personDepartment Deal - £125 per person (for two or more colleagues attending from the same school or college)PGCE / NQT - £75 per person

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Teaching & learning products

AS Microeconomics Revision Guide

This 48-page, full-colour printed revision guide written by tutor2u's Geoff Riley is designed to support students preparing for their AS Economics exams on microeconomics.


AQA A2 Economics Worked Answers (2014)

Exemplar A Grade answers to the ECON3 and ECON4 exam papers sat in June 2014