In this video we’ll examine managed floatexchange rates and see how they are managed.
You should have a basic understanding of exchangerates and understand how they are determined.
A managed float combines part of the freelyfloating exchange rate mechanism with the fixed exchange rate regime.
It looks a bit scary when we consider thediagram but we’ll go through that step by step.
As mentioned in the previous video, Chinano longer operates a fixed exchange rate system.
It is currently operating a managed floatexchange rate.
The government permits fluctuations of 2%from a fixed rate but will intervene at fluctuations beyond this.
If the currency appreciates or depreciatesmore than 2%, the Chinese government will take action to bring it back within this range.
In the diagram we see two purple lines whichrepresent the range between which the exchange rate can fluctuate, including an upper limitand lower limit.
I’ll use the same diagram as I did beforein the video on the fixed exchange rate to demonstrate how the government may interveneto adjust the value of the currency.
If there is an increase in the demand foryuan the currency will appreciate against the dollar.
Should this value exceed the upper limit setin this managed float, the government will intervene, perhaps by increasing the supplyof yuan in the foreign exchange market and driving down the value of the Chinese currencyand returning it to a level acceptable within the upper and lower limits.
When considering the diagram for this exchangerate system it is important to be able to graph it as well as understand the logic behindit.
If there is a fluctuation in the exchangerate beyond a certain point, the government will take action to return it to a value withinthe pre-determined range.
Now let's take a look at a past CIE multiplechoice question.
This question comes from winter 2002, paper2.
Which of the following combinations of changesindicates that a country is operating a managed float? The best choice here will be the option thatreflects a change in the nominal exchange rate matched by an action to offset the change.
Let’s make up an example.
If J-bucks depreciate against the US dollarby 20% and the government wants to prop up the J-buck, they will flood the foreign exchangemarket with $1 billion taken from the currency reserves.
They can use these dollars to buy J-bucks,thereby increasing the demand for it and cause the J-buck to appreciate.
Our correct answer here is A.
That wraps up this video on managed floatexchange rates.
Once again, I hope you’ve found this videohelpful and if you have any questions or comments, do leave them below, email me at enhancetuition@gmail.
Comor tweet me @enhancetuition.
For now that’s us done and I will see youin the next one!.