Understanding Managed Floating Exchange Rate
Managed floating exchange rate is a currency exchange rate system that combines elements of a free floating exchange rate system as well as a fixed exchange rate system. In this system, currency exchange rates are determined by the foreign exchange market, but monetary authorities can intervene to change currency exchange rates. This intervention was carried out with the aim of reducing volatility and excessive exchange rate fluctuations, which could have a negative impact on the country’s economy. The background to the use of managed floating exchange rates originates from changes in the international banking and financial system in the 20th century, especially after the collapse of the Bretton Woods system. The Bretton Woods system was an agreement between countries that decided to tie the exchange rate of their currencies to the United States dollar, which in turn was tied to gold. However, the inability to maintain exchange rate stability and economic pressures led to the collapse of the Bretton Woods system in the early 1970s.
In an ever-changing environment, many countries are seeking more flexible ways of determining their currency exchange rates than the extremes of fixed exchange rates or free-floating rates. Thus, the managed floating exchange rate was born as an alternative that combines the flexibility of a free floating exchange rate with the stability offered by a fixed exchange rate. In general, managed floating exchange rate systems have become more popular in recent decades, as countries realize the importance of keeping their exchange rates stable but still able to adapt to changes or global economic conditions. Some of the advantages of this system include faster absorption of external economic effects, adjustment to global markets, and prevention of excessive exchange rate fluctuations.
Advantages of Managed Floating Exchange Rate
The main advantage of the Managed Floating Exchange Rate system lies in the flexibility of exchange rate changes. In this system, currency exchange rates are allowed to fluctuate within a certain range set by the government or central bank. This flexibility allows the economy to adjust more easily to changes in the global economy, such as increases or decreases in commodity prices and changes in interest rates. In this way, the negative impact of external exchange rate fluctuations can be minimized.
Another advantage gained from implementing the Managed Floating Exchange Rate system is the government’s ability to control economic stability. Through the monetary authority which has the authority to regulate exchange rate policy, the government can intervene in the foreign exchange market to maintain the stability of the domestic currency exchange rate. This intervention can be carried out through buying or selling foreign currency, as well as adjusting the reference interest rate. This provides room for the government to control inflation and economic growth.
The Managed Floating Exchange Rate system also contributes to balancing capital flows between countries. Flexible monetary policy allows countries with balance of payments surpluses or deficits to adjust their currency exchange rates as needed. This creates more balanced conditions in international exchange and reduces global economic instability. Balancing capital flows also helps prevent prolonged deficits or surpluses that are detrimental to the economy.
Lastly, the Managed Floating Exchange Rate system is effective in preventing excessive speculation in the foreign exchange market. Because the government has the ability to intervene in the market if necessary, the potential risk of speculation is reduced because investors will be more careful in making transactions. Implementing this policy also reduces the possibility of speculative attacks that could cause a currency crisis.
Disadvantages of Managed Floating Exchange Rate
Managed floating exchange rates have several disadvantages, one of which is the risk of dependence on government intervention. In this system, the government’s role is very important to ensure the stability of currency exchange rates. However, this can lead to over-reliance on government policies and vulnerability to political changes or external economic pressures. At the same time, this condition can also pose a risk of economic instability if government intervention is not appropriate to needs.
Apart from that, the possibility of economic policy conflicts between countries is also a drawback of the managed floating exchange rate system. Governments may have different perspectives on how a currency should be managed, especially in the context of international trade. This could result in disharmony in economic policies at the international level, which could ultimately affect global economic growth and development.
The potential for higher exchange rate volatility is also a drawback of the managed floating exchange rate system. Even though the government is present to control currency exchange rates, it is not uncommon for these efforts to actually cause exchange rate fluctuations that are higher than in a pure floating exchange rate system. This is because investors and speculators may try to guess and take advantage of government intervention in regulating currency exchange rates.
Case Study and Application of Managed Floating Exchange Rate in Several Countries
In the case of Brazil, the implementation of a managed floating exchange rate has helped the country’s economy control inflation and reduce pressure on the currency exchange rate. Brazil’s central bank has managed to stabilize the real exchange rate by selling or buying US dollars on the foreign exchange market when necessary. With these policies, Brazil has experienced increased economic stability, although challenges such as political and fiscal pressures remain.
Canada, which has an economy largely dependent on exports of crude oil and other commodities, also benefits from a managed floating exchange rate system. When oil prices fell significantly several years ago, the Canadian dollar exchange rate also weakened. This helps maintain the competitiveness of products exported by Canada and maintain economic growth. However, this also makes the Canadian economy vulnerable to changes in commodity prices which are often volatile.
From the case studies above, we can see that the implementation of managed floating exchange rates has helped several countries maintain their economic stability and reduce the negative impact of exchange rate fluctuations. However, the success of this system is highly dependent on the quality of interventions carried out by central banks and other external factors such as politics, fiscal and global economics. Therefore, it is important for every country that implements this system to always carry out comprehensive analysis and strengthen coordination between the central bank, government and markets in maintaining the stability of their currency.
