Does this sound familiar? Floating exchange rate system.
Probably not.
Imagine a system where the value of currencies is determined by the interplay of the foreign exchange market instead of government intervention.
However, in most cases, central banks of a country always try to defend their currency rates to a particular range.
They do this by buying or selling their currency if the situation warrants.
What is Floating Exchange Rate?
When the price of a nation’s currency is determined by the supply and demand of the forex market, which is relative to other nation’s currencies.
While in a fixed exchange rate, the government determines the currency rate.
Beginning of floating exchange rate system
It all started in the Bretton wood conference, and this was in July 1944. The World Bank and the international monetary fund (IMF) was also established in this conference.
Before this time, the idea of this system was only just a dream.
Think about this for a moment.
There was a specific quantity of gold linked to every currency. This method was used around the world as a way of evaluating currency as of that time.
How floating exchange rate system Work?
Let’s see exactly how this works:
In this system, most traded currencies change in relative value constantly.
Let me give you some examples,
Today one U.S. dollar might be able to buy on the British pound, but by tomorrow it might only buy 0.95 British pounds. In this instance, the value floats.
Key Feature of floating exchange rate system
One of the critical feature of this system is that it reduces the need for nations to have currency reserves.
That’s not all
Because an exchange rate target is absent, the opportunity for currency speculation is reduced.
Flexible Exchange Rate
It is also known as flexible exchange rate, low demand for a currency, causes the value of that currency to decrease just like any other services or products.
Float Evolution
Today, in the forex market the most traded currencies, such as the British pound, the Euro, the Japanese yen, and the U.S. dollar, all these currencies have a floating exchange rate.
Conclusion
When it comes to this rate system, the main argument is that monetary makers can use the exchange rate to achieve competitive advantage.
Even if the strong US dollar depreciates or appreciate, the monetary policymakers will still use it to stabilize the price level.
Check Out: Exchange Rate Latest News from 21st to 27th June 2021