Monday, August 10, 2009

managed floating

The final hybrid arrangement of fixed and flexible exchange rates that we consider is designated by the managed floating, the term that is generally applied to the current international monetary system. In general, a managed floating regime is characterized by some interference with exchange rate movements, but the intervention is discretionary on the part of the monetary authorities. In other words, there are no announced guidelines or rules for intervention, no parity exchange rates or announced target rates, and no announced limits for exchange rate variations. Rather, a country may intervene when it judges that it would be well served by doing so. For example, intervention to appreciate the home currency (or to keep it form depreciating so fast) might be desirable to fight domestic inflationary pressures, or intervention to prevent an appreciation might be desirable for assisting in reaching an employment target. Sometimes the intervention by a particular country takes the from of coordinated intervention with other countries, such as when several industrialized nations agreed to drive the U.S. dollar down in value in 1985 and then agreed in 1987 that the dollar had fallen far enough. In general, a country tends to intervene in order to slow down a movement in the exchange rate in particular direction, a type of intervention called leaning against the wind. If the intervention is designed to intensify the movement of the currency in the direction in which it is already moving, the intervention is called leaning with the wind.
An advantage cited for managed floating is that the country is not locked into some prearranged course of action by formal rules and announcement. This greater freedom to tailor policy to existing circumstances is thought to be superior to sticking to a set of rules devised in some prior period that is no longer relevant. In addition, in contrast to a fixed-rate system, the exchange rate under managed floating is allowed to play some role in eternal sector adjustment. Further, internal policy is not constrained to the extent that it is under fixed-rate system. In comparison with a purely flexible-rate system, the country is able to moderate wide swings in the exchange rate that can have adverse price level risk and resource movement implications. A speculation is also more difficult because speculators do not know the timing of the intervention, the potential size of the intervention, or even necessarily the direction of the intervention.
Working against the concept of managed floating is the possibility that, without a set of rules and guidelines for each country, various nations may be working at cross – purposes. For example, Japan may want to moderate a rise in the value of the yen in terms of dollars at the same time that the U.S. wants to drive the dollar down in terms of the yen. A form of economic warfare can than ensue. In addition, because exchange rates can vary substantially with a managed float, there is still a possibility that traders may be wary of full participation in international trade because of the risks of exchange rate variation.
there is a danger of abuse to the free market allocation of resources according to comparative advantage if countries use intervention to engage in what is called exchange rate protection. A contrived comparative advantage can be gained from such protection , and world resources may not be used in their most efficient manner. For example, many observers thought that Japan was intervening in the early 1980s to keep the value of the yen down in exchange markets . the advantage to Japan of this undervaluation of the Yen would be that Japan‘s enhanced exports and depressed imports would provide a boost to Japanese GNP. when countries tend to manipulate their managed floats in this fashion to pursue particular goals at the expense of other countries , the behavior is referred to as dirty floating.
Finally , some economists have questioned the ability of single country to meaningfully influence its exchange rate in any event. the size of any country‘s foreign exchange reserves is very small relative to the size of total foreign exchange market activity. the ability to convince foreign exchange market participants that the government is both willing and able to influence the exchange rate is critical for successful intervention.

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