Managed Currency: Meaning, How it Works, Benefits (2024)

What Is a Managed Currency?

A managed currencyis one whose value and exchange rate are influenced by some intervention from a central bank.This may mean that the central bank increases, decreases, or maintains a steady value, sometimes linked to another currency.

Key Takeaways

  • A managed currency is one where a nation's government or central bank intervenes and influences its value or buying power on the market, especially in foreign exchange markets.
  • Central banks manage currency by issuing new currency, setting interest rates, and managing foreign currency reserves.
  • Monetary authorities also manage currencies on the open market to weaken or strengthen the exchange rate if the market price rises or falls too rapidly.
  • A completely unmanaged currency is said to be a "free-float," although very few such currencies exist in practice.

Understanding Managed Currencies

Currency is the current liability and demand instrument of a financial institution or government, which takes the form of accounting credits and paper notes that may circulate as a generally accepted substitute formoney and may be legally designated as the legal tender in a country.A central bank, government treasury, or other monetary authority manages a currency, and is typically given free control over the production and domestic distribution of the money andcredit for a country. In this sense, all currencies are managed currencies with respect to their domestic supply and circulation, with the ostensible goals of price stability and economic growth.

A central bank may also specifically intervene in foreign currency exchange markets to manage a currency's exchange rate in the global market. In general, all currencies are also managed currencies in this sense as well, in that the currency manager is the one who chooses to either float their currency or actively intervene in the exchange markets. In colloquial use among traders, the degree to which the currency issuer actually chooses to actively intervene determines whether a currency is considered a managed currency or not at any given point in time.

This degree of active management determines whether the currency has a fixed or floating exchange rate. Most currencies today are nominally free-floating on the market versus one another, but central banks will step in when they judge it useful to support or weaken a currency if the market price falls or rises too much in relation to other currencies. In the most extreme cases, managed currencies may have a fixed or pegged exchange rate that is maintained through continuous, active management versus other currencies.

How a Managed Currency Works

Central banks manage a nation's currency through the use of monetary policies, which range widely depending on their country. These economic policies usually fall into four general categories as follows:

  1. Issuing currency and settinginterest rateson loans and bonds to control growth, employment, consumer spending, and inflation,
  2. Regulating member banks through capital orreserve requirementsandproviding loans and services for a nation’s banks and its government,
  3. Serving as an emergencylenderto distressed commercial banks and sometimes even the government bypurchasing government debt obligations,
  4. Buying and selling securities in the open market, including other currencies.

Other techniques to manipulate currency values and exchange rates may be used, such as direct currency or capital controls. New ones are often being developed, which are collectively known as unconventional or non-standard monetary policy. Central banks intervene in the value of their currencies via activist monetary policy to influence domestic price inflation rates and their nations' GDP and unemployment rates, which also affect their value in foreign exchange.

These actions raise or lower the market value of currencies, in terms of other currencies or in terms of real goods and services, by altering the supply available on the market. Managing the market value of their currencies (or their inverse—price levels) in both domestic markets and foreign exchange is generally understood to be a primary responsibility of monetary authorities.

Types of Currency Management

Most of the world’s currencies participate to some degree in a floating currency exchange system.In a floating system, the prices of currencies move relative to one another based on market demand for the currencies' foreign exchange.The global foreign exchange market, known as the forex (FX), is the largest and the most liquidfinancial market in the world, with average daily volumes in the trillions of dollars. The currency exchange transactions can befor thespotprice,which is the current market price, or for anoptionsforward deliverycontract for future delivery.

When you travel to foreign countries, the amount of foreign money you can exchangeyour dollar for at a currency kiosk or bank will vary depending on the fluctuations in the forex market and will be the spot price.

When currency price changes happen solely because of domestic money supply and demand interacting with foreign exchange demand, it is known as a clean floator a pure exchange. Virtually no currencies genuinely fall into the clean float category. All of the major world currencies are managed, at least to some extent. Managed currencies include, but are not limited to the U.S. dollar, the European Union euro, the British pound, and the Japanese yen. However, the degree to which nations’ central banks intervene varies.

In afixed currency exchangethe government orcentral bankpegs the rate toa commodity, such as gold, or to another currency or a basket of currenciesto keep its value within a narrow band andprovide greater certainty for exporters and importers.The Chinese yuan was the last significant currency to use a fixed system. China loosened this policy in 2005 in favor of a form of managed floating currency system, where the value of the currency is allowed to float within a selected range.

Why Use Managed Currency?

Genuine floating currency exchange can experience a certain amount of volatility and uncertainty. For example, external forces beyond government control, such as the price of commodities, like oil, can influence currency prices. A government will intervene to exert control over their monetary policies,stabilize their markets, and limit some of this uncertainty.

A country may control its currency, for example, by allowing it to fluctuate between a set of upper and lower bounds. When the price of the money moves outside of these limits, the country’s central bank may purchase or sell its own or other currencies.

In some cases, the central bank of one government may step in to help manage the currency of a foreign power. In 1995, for instance, the U.S. government bought large quantities of Mexican pesos to help boost thatcurrency and avert an economic crisis when the Mexican peso began to lose value rapidly.

Managed Currency: Meaning, How it Works, Benefits (2024)

FAQs

What is managed currency? ›

A managed currency is one where a nation's government or central bank intervenes and influences its value or buying power on the market, especially in foreign exchange markets. Central banks manage currency by issuing new currency, setting interest rates, and managing foreign currency reserves.

What are the benefits of managed exchange rates? ›

Flexibility: Allows currency to adjust based on market forces. Economic Stability: Mitigates extreme fluctuations, reducing risks. Monetary Autonomy: Permits independent monetary policies. Trade Competitiveness: Enhances exports and trade growth.

What is the benefit of using currency? ›

Regardless of the form it takes, all currency has the same basic goals. It helps encourage economic activity by increasing the market for various goods. And it enables consumers to store wealth and therefore address long-term needs.

What are the benefits of currency control? ›

Exchange controls are government-imposed limitations on the purchase and/or sale of currencies. These controls allow countries to better stabilize their economies by limiting in-flows and out-flows of currency, which can create exchange rate volatility.

How do you manage currency exchange? ›

3 Ways to Manage Foreign Exchange Risk
  1. Establish a forward contract with a bank or foreign exchange service provider. ...
  2. The exporter accepts foreign currency payments only with cash in advance. ...
  3. Match foreign currency receipts with expenditures.

What is an example of a country with a managed exchange rate? ›

Managed float system is used in Japan, Mexico, Thailand, Turkey, Sweden, Israel, Brazil, and India.

What is a managed exchange rate in simple words? ›

A managed floating exchange rate (also known as dirty float') is an exchange rate regime in which the exchange rate is neither entirely free (or floating) nor fixed. Rather, the value of the currency is kept in a range against another currency (or against a basket of currencies) by central bank intervention.

What are the advantages and disadvantages of a managed exchange rate system? ›

Answers from top 5 papers. The main advantage of the managed floating exchange rate system is that it allows for flexibility in responding to economic conditions. However, a disadvantage is that it can lead to currency manipulation and trade imbalances.

What are the pros and cons of currency exchange? ›

Easy accessibility, low investment requirements, and high leverage are the top advantages of currency trading. However, market volatility and counterparty risk are the major drawbacks of forex trading.

How does currency work? ›

Key Takeaways. Currency is a generally accepted form of payment usually issued by a government and circulated within its jurisdiction. The value of any currency fluctuates constantly in relation to other currencies. Currency is a tangible form of money, which is an intangible system of value.

What is the strongest currency in the world? ›

Kuwaiti Dinar (KWD)

The Kuwaiti dinar is the strongest currency in the world, with 1 dinar buying 3.26 dollars (or, put another way, $1 equals 0.31 Kuwaiti dinar). Kuwait is located on the Persian Gulf between Saudi Arabia and Iraq, and the country earns much of its wealth as a leading global exporter of oil.

What is the weakest currency in the world? ›

What Is the Weakest Currency in the World? The weakest currency in the world is the Iranian rial (IRR). The USD to IRR operational rate of exchange is 371,992, meaning that one U.S. dollar equals 371,922 Iranian rials.

How does currency control work? ›

Exchange controls act as a tax on the foreign currency required for purchasing foreign goods and services and, by raising the domestic price of imports, they tend to reduce trade.

Who benefits from a strong currency? ›

A strengthening dollar means U.S. consumers benefit from cheaper imports and less expensive foreign travel. U.S. companies that export or rely on global markets for the bulk of their sales are financially hurt when the dollar strengthens.

Should we get rid of cash? ›

For instance, using cash instead of credit or debit cards may help keep some people from overspending, because you can see how little is left in your wallet after every purchase. In short, getting rid of cash would impose hardships on society's most vulnerable people and could jeopardize our privacy.

What is an example of a managed float currency? ›

By far the most significant system of managed floating exchange rate in recent years is the Chinese currency regime. At the start of each trading day, China's central bank sets a 'reference rate' against which the renminbi is allowed to rise or fall no more than 2 per cent against USD in onshore trading.

What is the difference between a fixed and managed exchange rate? ›

A fixed exchange rate denotes a nominal exchange rate that is set firmly by the monetary authority with respect to a foreign currency or a basket of foreign currencies. By contrast, a floating exchange rate is determined in foreign exchange markets depending on demand and supply, and it generally fluctuates constantly.

What are the three types of currency? ›

Economists differentiate among three different types of money: commodity money, fiat money, and bank money. Commodity money is a good whose value serves as the value of money.

What is the difference between a floating and managed exchange rate? ›

A clean float, also known as a pure exchange rate, occurs when the value of a currency is determined purely by supply and demand. A managed currency is one whose value and exchange rate are affected by the intervention of a central bank.

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