Managed Float

Q: What is a managed float?

Managed float is when the controlling financial body will manipulate the exchange rate at will, choosing to let it free float, fixed to a rate, or kept within a desirable range.

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Imagine you are holding a dollar; If you had the power to control how much that dollar is worth, what would you do? Would you only change the value if it started to fall? Would you raise the value of the dollar so you can buy more things? Would that cause inflation that would negate the growth in value? Believe it or not but countries have some control or pre-planned lack of control over the exchange rate of their currency. This explanation will fill you in on all the details you need to know about the exchange rates in managed float, so keep reading on!

Managed float definition

Before we can cover the definition of managed float, we need some background information to make it clear. The global financial market has hundreds of currencies with varying values and exchange rates circulating the globe, fluctuating in price. An exchange rate will affect a country's ability to purchase imports, as well as determine the attractiveness of their exports.

Some countries, like the United States, operate on what is called a free float, where the exchange rate value of the dollar is determined by supply and demand in the global market. Other countries will peg their currency either to another country's currency or at a fixed rate.

What happens when a country determines they don't want a free-floating market exchange rate but also don't want a fixed one either? These countries then practice a mix of both, which is referred to as a managed float, also called a dirty float.

Managed float is when the controlling financial body will manipulate the exchange rate at will, choosing to let it free float, fixed to a rate, or kept within a desirable range.

A managed float can be anything the controller wants it to be. If they think the market is stable, they can allow it to free float, allowing efficient allocations. It can also be when the controlling body intervenes to control market fluctuations in the exchange rate or set it to a target level.

To better understand exchange rates, it'll be helpful to cover some relevant terms.

When a country's floating exchange rate is increasing, it's generally referred to as appreciation. When a managed exchange rate appreciates, it is referred to as revaluation.

On the other hand, when a country's floating exchange rate is decreasing, it's called depreciation. When a managed exchange rate depreciates, it is referred to as devaluation.

Revaluation - an increase in the value of the domestic currency with respect to a foreign currency in a managed float system.

Devaluation - a decrease in the value of the domestic currency with respect to a foreign currency in a managed float system.

Free float vs. managed float

What is the difference between free float vs. managed float? They share some similarities, especially since a managed float can choose to free float. Let's start by establishing what a free float is as well as its advantages.

A free float is when an exchange is not manipulated in any way; it is only changed by market forces. For simplicity, we'll refer to the dollar. The value of the dollar on the foreign exchange market will only change if the supply or demand for the dollar shifts. Let's consider an example, as illustrated in Figure 1 below.

Managed Float Free float example StudySmarter Fig. 1 - Free float example

Suppose that a new American product has countries all over the world buying it. The global pandemic hits, and the demand for this product falls drastically. This leads to a fall in demand for the dollar, as fewer dollars are required to purchase the American good. In Figure 1 above, this is shown by the demand curve for dollars shifting leftwards from D1 to D2. With a floating exchange rate, this will depreciate the value of the dollar as its demand falls.

Alternatively, shifts in supply can change the value of the currency. Suppose that the Federal Reserve increases the money supply. Now dollars are not as scarce on the market, so they will drop in price or value. This is shown by the supply curve for dollars shifting from S1 to S2. This leads to a depreciation of the dollar.

The managed float is a free float with some state control. To clarify the difference between managed and free float, we'll list the tools that are used to manipulate a managed float.

There are a few ways that controlling bodies manage the exchange rate. One way of controlling the exchange rate is monetary policy, such as decreasing the interest rate. Monetary policy refers to the manipulation of the money supply through interest rate channels. The following are examples of actions used to maintain a managed float.

1. Decrease in interest rate
2. Buying foreign currency
3. Foreign exchange control

Managed float exchange rate

Why would a country have a managed float exchange rate? Well, there are several advantages to having a managed float and a few drawbacks. Let's consider how the exchange rate affects trade within the domestic country and its imports and exports.

Exports are affected by the exchange rate because it alters the price consumers have to pay.

Part of managing an exchange rate is keeping it partially fixed within the desired range. Let's see some examples of this.

Switzerland is an example of managed float. The 2011 monetary policy lowered interest rates. The 2011 price ceiling in Swiss francs was at 0.83 euro cents.

Managed float system is used in Japan, Mexico, Thailand, Turkey, Sweden, Israel, Brazil, and India.

Managed exchange rate diagram

A managed exchange rate is most easily understood by viewing it on a diagram. Figure 2 below is a supply and demand graph for a given currency. The X-axis is the quantity of the currency available, and the Y-axis is the exchange rate. The supply curve (S) represents the available supply of money to be traded. The demand curve (D) is the market demand for the currency.

Because this graph represents a managed exchange rate, we know that the equilibrium exchange rate (ER*) is being monitored and controlled. The equilibrium quantity (Q*) is the quantity of money that maintains the desired exchange rate. This is because changes in the quantity of currency will cause the exchange rate to fluctuate, so the quantity of currency must be monitored to maintain it.

Managed Float Managed float example StudySmarter Fig. 2 - Managed float example

Figure 2 above provides a visual representation of how to manage a currency. Upper and lower limits are set to allow the currency to float to some degree. If the exchange rate approaches or goes past the limit, then the governing body will take steps to control it. This is usually done through tools such as monetary policy.

Imagine a fictional country with a regular economy, imports, and exports, and we'll call this country Tim. Tim manages their exchange rate to keep the price ideal for its exports. So central bank in Tim states that their ideal exchange rate is 0.7. Which of the following boundaries would be more effective at keeping the exchange rate in a managed float?a. If Tim sets an upper limit of 0.7 and a lower limit of 0.5.b. If Tim sets an upper limit of 0.8 and a lower limit of 0.6.Answer: b.a. If Tim sets an upper limit of 0.7 and a lower limit of 0.5, it may be difficult to attain the desired exchange rate of 0.7 as the upper boundary lies at this number. Every time the exchange rate goes above this number, an intervention will be required.b. If Tim sets an upper limit of 0.8 and a lower limit of 0.6, then there will be both an upper and lower bound which gives some flexibility for the exchange rate to deviate slightly above or below the target. An intervention will be required only if the exchange rate goes beyond these pre-defined boundaries.

Pros and cons of managed floating exchange rate

What are the pros and cons of a managed floating exchange rate? Let's go over them below!

Pros of managed floating exchange rate:
1. Improve the balance of trade
2. Reduce the risk of deflationary recession
3. Re-balance the economy
4. Curb demand-pull inflationary pressures
5. Reduce prices of import
6. Provides stability for investors and consumers

Cons of managed floating exchange rate:
1. Can lead to cost-push inflation
2. Less flexibility for the use of interest rates by the government
3. Repercussions of setting a 'wrong' rate
4. Difficult to manage
5. Can send an economy into a recession
6. Investors leave if exchange rate is undesirable for them.

Managed Float - Key takeaways

Managed float is when the controlling financial body will manipulate the exchange rate at will, choosing to let it free float, fixed to a rate, or kept within a desirable range.
Revaluation is an increase in the value of the domestic currency with respect to a foreign currency in a managed float system.
Devaluation is a decrease in the value of the domestic currency with respect to a foreign currency in a managed float system.
Managed float is essentially the same as the free float but where the currency value is allowed to fluctuate within certain limits.
Managed float is maintained through tools such as monetary policy.

Frequently Asked Questions about Managed Float

Managed float is when the controlling financial body will manipulate the exchange rate at will, choosing to let it free float, fixed to a rate, or kept within a desirable range.

There are various reasons why countries go for managed exchange rate system, which allow them to:
1. Improve the balance of trade
2. Reduce the risk of deflationary recession
3. Re-balance the economy
4. Curb demand-pull inflationary pressures
5. Reduce prices of import
6. Provides stability for investors and consumers

A free float is when an exchange is not manipulated in any way; it is only changed by market forces. The managed float is a free float with some state control.

Managed float system is used in Japan, Mexico, Thailand, Turkey, Sweden, Israel, Brazil, and India.

Upper and lower limits are set to allow the currency to float to some degree. If the exchange rate approaches or goes past the limit, then the governing body will take steps to control it. This is usually done through tools such as monetary policy.

Final Managed Float Quiz

Managed Float Quiz - Teste dein Wissen

Question

What is a managed float?

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Answer

Managed float is when the controlling financial body will manipulate the exchange rate at will, choosing to let it free float, fixed to a rate, or kept within a desirable range.

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Question

Why do countries go for managed exchange rate system?

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Answer

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Question

What is the difference between a floating and managed exchange rate?

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Answer

A free float is when an exchange is not manipulated in any way; it is only changed by market forces. The managed float is a free float with some state control.

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Question

Which countries use managed float?

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Answer

Managed float system is used in Japan, Mexico, Thailand, Turkey, Sweden, Israel, Brazil, and India.

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Question

How is managed float exchange rate determined?

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Answer

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Question

What is revaluation?

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Answer

Revaluation is an increase in the value of the domestic currency with respect to a foreign currency in a managed float system.

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Question

What is devaluation?

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Answer

Devaluation is a decrease in the value of the domestic currency with respect to a foreign currency in a managed float system.

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Question

Explain the difference between a managed float and a free float?

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Answer

Managed float is essentially the same as the free float but where the currency value is allowed to fluctuate within certain limits.

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Question

How is the managed float maintained?

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Answer

Managed float is maintained through tools such as monetary policy.

Show question

Question

What are some cons of managed floating exchange rate?

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Answer

Cons of managed floating exchange rate:
    1. Can lead to cost-push inflation
    2. Less flexibility for the use of interest rates by the government
    3. Repercussions of setting a 'wrong' rate
    4. Difficult to manage
    5. Can send an economy into a recession
6. Investors leave if exchange rate is undesirable for them.

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Question

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Answer

If Tim sets an upper limit of 0.7 and a lower limit of 0.5.

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Question

When a country's floating exchange rate is increasing, it's generally referred to as ____.

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Answer

appreciation

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Question

When a country's floating exchange rate is decreasing, it's called ____.

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Answer

depreciation

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Question

Name some examples of actions used to maintain a managed float.

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Answer

1. Decrease in interest rate
2. Buying foreign currency
3. Foreign exchange control

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More about Managed Float

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Managed Float

Managed Float

Managed float definition

Free float vs. managed float

Managed float exchange rate

Managed exchange rate diagram

Pros and cons of managed floating exchange rate

Managed Float - Key takeaways

Frequently Asked Questions about Managed Float

What is a managed float?

Why do countries go for managed exchange rate system?

What is the difference between a floating and managed exchange rate?

Which countries use managed float?

How is managed float exchange rate determined?

Final Managed Float Quiz

Managed Float Quiz - Teste dein Wissen

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