Exchange rates ~ Try to explain... (1 Viewer)

[bell531]

Ok, can anyone give a proper explanation of the floating, fixed, flexible and managed exchange rate systems? I understand floating, and I thought I understood fixed, but my textbooks seem to have conflicting answers and so after an hour of trying to understand them i've come here. Can anyone help?

 

[LordPc]

from memory:

floating is just determined by the free market (ie S & D)
fixed: is fixed.
flexible: can move up and down but not too much
is managed the same as flexible peg? where it is floating but each day it is pegged at a certain point.

i doubt your textbooks have conflicting answers. they probably mean the same thing but are just worded poorly or there are slight terminology differences which seem to make them conflicting but dont. ask your teacher, they'll know for sure and'll be able to explain it properly.

 

[bell531]

from memory:

floating is just determined by the free market (ie S & D)
fixed: is fixed.
flexible: can move up and down but not too much
is managed the same as flexible peg? where it is floating but each day it is pegged at a certain point.

i doubt your textbooks have conflicting answers. they probably mean the same thing but are just worded poorly or there are slight terminology differences which seem to make them conflicting but dont. ask your teacher, they'll know for sure and'll be able to explain it properly.

Ok, thanks. I've thought some more about it, and seem to understand it better, but not fully. Floating is simple. Fixed is...fixed, but does the central bank buy and sell domestic currency in order to keep it at that fixed price, or does it stay wherever they set it? And is flexible/managed (I'm assuming they're the same thing) a system where the central bank manages the currency so that it stays within a certain value (e.g. between 0.75c and 0.85c) but is allowed flexibility between these values?

I will definitely ask my teacher on Monday, even if I doubt she'll help my understanding, but I really want to know straight away. Not for any reason, just cos it's bugging me.

Thanks for ur help BTW

 

[LordPc]

Ok, thanks. I've thought some more about it, and seem to understand it better, but not fully. Floating is simple. Fixed is...fixed, but does the central bank buy and sell domestic currency in order to keep it at that fixed price, or does it stay wherever they set it?

my understanding is that when a currency is fixed, it is just fixed. banks dont buy and sell the currency to keep it at the fixed price, its just that any trading of that currency is done at a specific price and thats it.

And is flexible/managed (I'm assuming they're the same thing) a system where the central bank manages the currency so that it stays within a certain value (e.g. between 0.75c and 0.85c) but is allowed flexibility between these values?

yea i think it is something like this. so that the currency cant drop or rise an extreme amount in one single day. it gives the currency some certain stability which is always nice

 

[gnrlies]

my understanding is that when a currency is fixed, it is just fixed. banks dont buy and sell the currency to keep it at the fixed price, its just that any trading of that currency is done at a specific price and thats it.

Well actually this might be what the central bank does, but implicit in this is the requirement for the central bank to buy and sell currency. In the same way as the RBA might say the cash rate is.... ; they still need to buy and purchas CGS in order to maintain that rate otherwise there would be a disequilibrium in the market.

In the case of fixed currencies, central banks need to either issue or recall currency in order to maintain equilibrium in the FOREX markets. You can imagine what would happen if they didn't; you would have a situation where people who want to see Australian dollars could not do so as there would not be enough buyers (and vice versa).

A central bank can increase the supply of a currency in two ways:

1 - It can hold large local currency reserves and release them or
2 - It can increase the money supply

But when you think about it they are essentially the same thing.

A central bank can decrease the supply of a currency by purchasing that currency of its holders. But to do this the central bank needs foreign currency reserves as they need to purchase the currency in a foreign currency. This is why central banks often do currency swaps with other central banks.

 

[bell531]

Well actually this might be what the central bank does, but implicit in this is the requirement for the central bank to buy and sell currency. In the same way as the RBA might say the cash rate is.... ; they still need to buy and purchas CGS in order to maintain that rate otherwise there would be a disequilibrium in the market.

In the case of fixed currencies, central banks need to either issue or recall currency in order to maintain equilibrium in the FOREX markets. You can imagine what would happen if they didn't; you would have a situation where people who want to see Australian dollars could not do so as there would not be enough buyers (and vice versa).

A central bank can increase the supply of a currency in two ways:

1 - It can hold large local currency reserves and release them or
2 - It can increase the money supply

But when you think about it they are essentially the same thing.

A central bank can decrease the supply of a currency by purchasing that currency of its holders. But to do this the central bank needs foreign currency reserves as they need to purchase the currency in a foreign currency. This is why central banks often do currency swaps with other central banks.

My teacher and classmates helped me understand, and all of what you have said seems to match up. Thanks for your help

 

[hamo321]

This is what i wrote in my essay about the different systems:


In the past Australia used different systems in determining the Australian exchange rate which included the fixed Exchange rate, Managed flexible Peg and the Flexible/Floating exchange rate system.The first ever exchange rate system used by Australia was the fixed exchange rate which was established in the beginning of 1976. Under this system the Reserve Bank of Australia or government would set and maintain the official exchange rate while buying and selling the currency in order to maintain Australia’s exchange rate at the desired level. Although this system worked effectively in the short term, Australia’s foreign currency reserves would dry up in purchasing the $A.

In November of 1976 Australia converted its system to a managed flexible peg, this system was similar to its previous system but instead it fixed the exchange rate on a daily basis and bought/sold the currency in maintaining the desired value of the $A. This system attained the same disadvantages as the fixed exchange rate where the foreign currency reserves would eventually wear out.

Lastly in 1983, Australia adopted the Floating exchange rate system where the official exchange rate was determined by the supply and demand of the $A, establishing the exchange rate at an equilibrium price where supply would meet demand. This system was the superior system because it did not have to buy/sell its own currency, foreign investment would improve and exports would ultimately increase.