📌 Fixed Exchange Rates
Fixed exchange rate.
How is it maintained?
- Buying/selling foreign currency reserves — if the currency is falling below the peg, the central bank buys the domestic currency using foreign reserves (reducing supply). If it's rising above, it sells domestic currency (increasing supply).
- Interest rate changes — raising interest rates attracts foreign capital, increasing demand for the currency to maintain the peg.
- Capital controls — restricting capital outflows to prevent downward pressure.
Under a fixed rate: revaluation = deliberate increase of the fixed rate. Devaluation = deliberate decrease. These are different from appreciation/depreciation (which are market-driven in floating systems).
🎛️ Managed (Dirty) Float
Managed exchange rate.
Most countries in practice use a managed float — the exchange rate floats freely most of the time, but the central bank steps in when movements become extreme. This is the most common system globally.
- The central bank has a 'band' or informal target range.
- Intervention happens through buying/selling reserves or adjusting interest rates.
- Combines the flexibility of floating with some stability of fixed rates.
- Also called a 'dirty float' because it's not purely market-driven.
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⚖️ Comparing Systems
| Feature | Floating | Fixed | Managed |
|---|---|---|---|
| Determined by | Market forces | Government peg | Mostly market + intervention |
| Stability | Volatile | Stable | Moderate |
| Monetary policy freedom | High | Low | Moderate |
| Reserves needed | Not needed | Large reserves | Moderate reserves |
| Auto-adjustment | Yes | No | Partial |
| Risk of speculation | High | High (attacks on peg) | Moderate |
The main trade-off: fixed rates provide stability but sacrifice monetary policy independence. Floating rates provide monetary freedom but create uncertainty.