Dirty Float: Occasional Exception to a Floating Exchange Rate System

A detailed explanation of Dirty Float, an occasional exception to a floating exchange rate system whereby a central bank intervenes.

A Dirty Float, also known as a Managed Float, refers to a foreign exchange system where a country’s currency value is primarily determined by market forces, but with occasional intervention by its central bank to stabilize or increase the value of the currency. This intervention is often done to achieve specific economic objectives.

Key Characteristics of Dirty Float

Market-Driven Value

In a dirty float system, the currency’s value is generally decided by supply and demand forces in the open market, similar to a pure floating exchange rate system.

Central Bank Intervention

Unlike a purely floating exchange rate system, the central bank occasionally intervenes in the currency market. This intervention can occur through direct buying or selling of the currency or through monetary policy adjustments.

Goals of Intervention

The primary goals of such interventions usually include:

• Stabilizing the currency: To avoid excessive volatility.
• Inflation control: To manage inflation by influencing import and export prices.
• Supporting economic growth: To make exports more competitive or imports cheaper, depending on economic strategies.

Example of Dirty Float in Action

A practical example of dirty float can be taken from the Indian Rupee (INR). The Reserve Bank of India (RBI) allows the Rupee to float according to market conditions but occasionally steps in to buy or sell the Rupee to control excessive fluctuations or to maintain a competitive exchange rate for trade purposes.

Historical Context

Historically, the transition from fixed exchange rate systems (such as the Bretton Woods system) to more flexible systems has led to the development of dirty floats. These systems offer a middle ground between fixed exchanges, which are heavily controlled, and completely free-floating currencies, which can be too volatile.

Applicability

Dirty floats are particularly useful for emerging economies that need to maintain some level of control over their currency to guard against market volatility while still benefiting from the efficiencies of a floating rate.

Comparison to Related Terms

Managed Float

A managed float is often used interchangeably with dirty float. Both terms refer to the same concept where the central bank intervenes in an otherwise market-determined exchange rate.

Pure Floating Exchange Rate

A pure floating exchange rate allows the currency’s value to be entirely driven by market forces without any central bank intervention.

FAQs

Q1: What triggers central bank intervention in a dirty float system?

A1: Central banks typically intervene to curb excessive volatility, control inflation, or maintain a competitive trade balance.

Q2: How does a dirty float impact international trade?

A2: By stabilizing the currency, a dirty float can reduce the risk for international traders, making exports and imports more predictable.

Q3: Are dirty floats sustainable in the long term?

A3: While dirty floats provide a balance between stability and flexibility, long-term sustainability depends on the central bank’s ability to effectively manage interventions without depleting reserves or causing undue market distortions.

References

• Mishkin, F.S., “The Economics of Money, Banking, and Financial Markets.”
• IMF, “Exchange Rate Arrangements and Policies.”

Summary

A dirty float, or managed float, strikes a balance between a purely floating and a fixed exchange rate system. It allows central banks to intervene and stabilize currency markets, providing a useful tool for managing economic conditions while retaining the benefits of market-driven currency pricing.

By understanding the mechanics, historical context, and practical examples of dirty floats, one can appreciate how they serve as crucial components of modern monetary policy.