The Exchange Rate Regimes

The exchange rate regime means a systematic plan lay down by the government of a country to administer its currency in respect to foreign currencies and the forex market. It had a very close relationship with the monetary policy of the nation these two generally dependent on lot of similar factors.

The basic types of exchange rate regimes in forex which are in fashion these days are such as:

The floating exchange rate regimes: In this type of exchange rate regime, the currency value is influenced by the movements in the financial market. In other words, the market controls the movements of the exchange rate.

The pegged exchange rate regimes: In this, the central bank of a country works towards keeping the currency rate from deviating too far from a target value by taking various measures.

The fixed exchange rate regimes: This exchange rate regime binds the currency of one country to another currency. This is most common example in this case are currencies such as the U.S. dollar or the euro.

The floating exchange rate regimes are most common and are extensively used in various countries of around the globe. Some common currencies where floating exchange rate regime is followed are British pound, United States dollar, Japanese Yen and Euro. This floating exchange rate regime is also called as the dirty float or a managed float. The reason behind is that because the governments always step in to address any excesses in the changes of value. Most of the times, the floating exchange rate regime has its own self adjusting mechanism, transmitting changes in fundamental dynamics across the economy. In that sense, a freely floating exchange rate regime cannot be defeated, unlike a pegged exchange rate regime.

In case of pegged exchange rate regimes in forex , there are following type three kinds of pegged floats which are the crawling bands, pegging with horizontal bands and crawling pegs. In crawling bands the rate is allowed to swing within a particular band or limit and the movements are based on a particular central value. This central value can be adjusted after definite periods. The entire process or exercise is carried out in such away that everything remains under control. In case of the crawling pegs the currency rates of remain constant. In case the rates are pegged with horizontal bands the rate would be allowed to move within a specified limit or band, which is one percent greater than the band.

In case of the fixed exchange rate regime, the currency rates are supposed to be converting directly to some other currency. There are times when in the pegged exchange rate, the currency may be attached to a group of other currencies or even precious metals like gold etc.

The type of exchange rate regimes in forex is an important consideration which you should consider before investing in any country. Since it can have a significantly impact on the economy. The latest trend in the US to advocate the so called bi-polar world of exchange rates, supporting the idea that in a world of free capital markets only the hardest currency peg or a completely free-floating currency are appropriate, and that anything else is unsustainable.