What is a managed currency?
A managed currency is one whose value and exchange rate are influenced by some intervention of a central bank. This can mean that the central bank increases, decreases or maintains a stable value, sometimes pegged to another currency.
- A managed currency is one in which the government or central bank of a nation intervenes and influences its value or purchasing power in the market, especially in the currency markets.
- Central banks manage the currency by issuing new currency, setting interest rates, and managing foreign currency reserves.
- The monetary authorities also manage currencies in the open market to weaken or strengthen the exchange rate if the market price rises or falls too fast.
- A completely unmanaged currency is said to be a “free float”, although in practice there are very few such currencies.
Understanding Managed Currencies
Currency is the current liability and instrument of demand of a financial institution or government, which takes the form of accounting credits and paper notes that can circulate as a generally accepted substitute for money and can be legally designated as legal tender in a country. A central bank, government treasury, or other monetary authority manages a currency and is usually given free control over the domestic production and distribution of a country’s money and credit. In this sense, all currencies are managed currencies with respect to their supply and domestic circulation, with the ostensible objectives of price stability and economic growth.
A central bank can also specifically intervene in foreign exchange markets to manage the exchange rate of a currency in the global market. In general, all currencies are also managed currencies in this sense, as the manager of the currency is the one who chooses to float their currency or actively intervene in the exchange markets. In colloquial usage among traders, the degree to which the currency issuer actually chooses to actively intervene determines whether or not a currency is considered a managed currency at any given time.
This degree of active management determines whether the currency has a fixed or floating exchange rate. Most of today’s currencies nominally float freely in the market against each other, but central banks will intervene when deemed useful to support or weaken a currency if the market price falls or rises too much relative to other currencies. In the most extreme cases, managed currencies may have a fixed or fixed exchange rate that is maintained through active and continuous management against other currencies.
How a managed currency works
Central banks manage a nation’s currency through the use of monetary policies, which vary widely by country. These economic policies generally fall into four general categories as follows:
- Issue currency and set interest rates on loans and bonds to control growth, employment, consumer spending, and inflation.
- Regulate member banks through capital or reserve requirements and provide loans and services for a nation’s banks and their government.
- Serving as an emergency lender for distressed commercial banks and sometimes even the government by purchasing government debt obligations,
- Buying and selling securities on the open market, including other currencies.
Other techniques can be used to manipulate currency values and exchange rates, such as direct currency or capital controls. New ones are often being developed, collectively known as unconventional or non-standard monetary policy. Central banks intervene in the value of their currencies through activist monetary policy to influence domestic price inflation rates and GDP in their countries and unemployment rates, which also affect their value in foreign currency.
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 in the market. It is generally understood that managing the market value of your currencies (or their reverse price levels) in both domestic and foreign exchange markets is a primary responsibility of monetary authorities.
Types of currency management
Most of the world’s currencies participate to some extent in a floating currency exchange system. In a floating system, the prices of currencies move relative to each other based on the demand of the foreign exchange market. The global currency market, known as forex (FX), is the world’s largest and most liquid financial market, with average daily volumes in the trillions of dollars. Currency exchange transactions can be for the cash price, which is the current market price, or for a forward delivery contract with options for future delivery.
When traveling to foreign countries, the amount of foreign money that you can exchange your dollar for at a currency kiosk or bank will vary depending on fluctuations in the foreign exchange market and will be the spot price.
When changes in the price of the currency occur solely because the supply and demand for national money interact with the demand for foreign exchange, it is known as a clean float or a pure change. Virtually no coin really falls into the clean float category. All the major currencies in the world are managed, at least to some extent. Managed currencies include, but are not limited to, the US dollar, the European Union euro, the British pound, and the Japanese yen. However, the degree of intervention of the central banks of nations varies.
In a fixed currency exchange, the government or central bank sets the rate to a commodity, such as gold, or to another currency or a basket of currencies to keep its value within a narrow band and provide greater certainty to exporters and importers. The Chinese yuan was the last significant currency to use a fixed system. China relaxed this policy in 2005 in favor of a form of managed floating currency system, where the value of the currency can float within a selected range.
Why use managed currency?
The genuine floating currency exchange can experience some volatility and uncertainty. For example, external forces beyond government control, such as the price of raw materials, such as oil, can influence currency prices. A government will intervene to exercise control over its monetary policies, stabilize its markets, and limit some of this uncertainty.
A country can control its currency, for example, by allowing it to fluctuate between a set of upper and lower limits. When the price of money moves outside these limits, the country’s central bank can buy or sell its own currency or others.
In some cases, a government’s central bank may step in to help manage a foreign power’s currency. In 1995, for example, the United States government bought large amounts of Mexican pesos to help boost that currency and avoid an economic crisis when the Mexican peso began to lose value rapidly.