Explanation of the floating exchange rate

The Floating exchange rate is a currency exchange rate management system adopted by a country or region in which the exchange rate relative to other currencies is determined by market supply and demand and the strength of the foreign exchange market, allowing the exchange rate to fluctuate freely within a certain range. Compared with the Fixed exchange rate system, under the Floating exchange rate, the exchange rate can fluctuate with changes in market demand and supply, reflecting different economic factors and policy influences.

The floating exchange rate means that the country does not regulate the fluctuation range of the currency exchange rate but allows it to fluctuate freely according to the supply and demand of the foreign exchange market. After World War I, the currencies of major countries in the world broke away from the Gold standard system and implemented a short-term floating Exchange rate regime.

After the collapse of the Bretton Woods system in 1973, countries around the world generally implemented floating exchange rates, which can be divided into free floating and managed floating.

Free floating is also called clean floating, which means that a government does not take any measures to prevent currency intervention and completely allows free floating.

Managed floating is also called dirty floating, that is, the Exchange rate regime in which the government intervenes under certain circumstances in order to keep its exchange rate relatively stable and avoid excessive fluctuations.

The floating exchange rates currently implemented by most countries are managed.

From the perspective of floating, the Floating exchange rate can be divided into three categories: single floating, joint floating, and pegging policy.

A single float refers to the situation where the domestic currency does not have a fixed price relationship with any foreign currency and floats separately according to supply and demand in the foreign exchange market, with the US dollar, Japanese yen, and other currencies floating separately.

Joint floating refers to the adoption of fixed exchange rates between currencies within a group of countries, setting the upper and lower limits for exchange rate fluctuations, and the obligation of the monetary authorities of each country to maintain a fixed exchange rate for currencies within the group while allowing other currencies outside of member countries to freely float.

The member states of the European Economic Community adopt the method of joint floating.

The implementation of peg policy refers to a floating Exchange rate regime that pegs a major currency, special drawing right, or European Currency Unit, fixes its exchange rate, and floats other currencies according to the fluctuation of major currencies.

At present, many developing countries have adopted a pegged policy. In addition, there is an Exchange rate regime adjusted according to a set of indicators.

Under the Floating exchange rate, market supply and demand determine the change of the exchange rate, which means that the exchange rate will fluctuate according to the transactions in the foreign exchange market and the investors' demand for money and the demand for hedging risks. If a country's economic growth is strong and capital inflows increase, it will lead to the appreciation of the country's currency. On the contrary, if a country's economy faces difficulties and Capital outflow increases, this will lead to the devaluation of the country's currency.

The advantage of the Floating exchange rate is that it can automatically adjust the exchange rate to respond to changes in the economic environment. It can help countries maintain competitiveness under external shocks and reduce dependence on foreign exchange reserves. In addition, the Floating exchange rate can also provide market signals, reflecting the health of the economy and market expectations.

However, the Floating exchange rate also has some challenges and risks. The volatility of exchange rates may trigger speculative behavior and market instability, which can have adverse effects on enterprises and the economy. In addition, the Floating exchange rate may lead to uncertainty about inflation, international trade, and investment.

In a word, the Floating exchange rate is a currency exchange rate management system, and its exchange rate relative to other currencies is determined by market supply and demand and foreign exchange market forces. It can automatically adjust exchange rates to reflect changes in the economic environment, but it also faces some challenges and risks.