Managed Currency: Controlled International Value and Exchangeability

An overview of managed currency, a type of currency whose international value and exchangeability is heavily regulated by its issuing country.

A managed currency is a type of currency whose international value and exchangeability are heavily regulated and controlled by its issuing country. Unlike floating currencies, which derive their values from market forces of supply and demand, managed currencies are subject to governmental or central bank interventions to stabilize or alter their exchange rates.

Types of Managed Currency Systems

Fixed Exchange Rate System

In a fixed exchange rate system, the value of a currency is pegged to another major currency (like the US Dollar) or a basket of currencies. The central bank maintains this fixed rate by buying and selling its currency in the foreign exchange market to counteract supply-demand imbalances.

Crawling Peg System

The crawling peg system is a variant where the exchange rate is adjusted periodically in small increments. This method allows for gradual and controlled value changes, preventing sudden and disruptive fluctuations.

Managed Float System

A managed float system combines elements of both fixed and floating systems. The currency value is largely determined by the market, but the central bank intervenes occasionally to stabilize the rate within a specified range.

Special Considerations

Economic Stability

Managed exchange rates can provide economic stability by preventing erratic currency fluctuations, which can be crucial for countries with volatile economies.

Inflation Control

Regulating the currency exchange rate can help control inflation. A stable currency discourages speculative attacks and market panics, thus fostering a stable economic environment.

Trade Deficits

Managed currencies can address trade deficits by adjusting the value to make exports cheaper and imports more expensive, balancing the trade dynamics.

Capital Control

Countries might impose capital controls alongside managed currencies to limit the flow of foreign capital, preventing excessive outflows or inflows that could destabilize the economy.

Historical Context

Bretton Woods System

One of the most notable examples of a managed currency system is the Bretton Woods System (1944-1971). Under this system, many world currencies were pegged to the US Dollar, which was convertible to gold at $35 per ounce. This fixed exchange regime facilitated international trade and investment post-World War II until its collapse in 1971.

China’s Yuan

Modern-day examples include the Chinese Yuan (Renminbi). The People’s Bank of China (PBOC) has frequently intervened in the forex market to manage the Yuan’s value, ensuring it aligns with the nation’s economic policies.

Applicability

Emerging Markets

Managed currencies are often utilized by emerging markets seeking economic stability and growth. They provide a buffer against global financial shocks and enhance investor confidence.

Developing Economies

Developing economies use managed exchange rates to protect local industries from aggressive foreign competition and to promote economic self-sufficiency.

Comparisons

Managed Currency vs. Floating Currency

• Managed Currency: Controlled by government intervention and regulatory mechanisms.
• Floating Currency: Determined by market forces without direct intervention, leading to potentially higher volatility.

Managed Currency vs. Pegged Currency

• Managed Currency: May use a mixture of fixed and floating strategies.
• Pegged Currency: Specifically fixed to another currency or a basket of currencies.

Related Terms

• Exchange Rate: The value at which one currency can be exchanged for another. It can be floating or regulated.
• Central Bank: A nation’s principal monetary authority, which manages currency value and regulation, including interventions to stabilize the exchange rate.
• International Monetary Fund (IMF): An international organization that provides financial assistance and advice to member countries to stabilize currencies and foster global monetary cooperation.
• Forex Market: The market in which currencies are traded. It is the largest financial market in the world, providing liquidity and price stability.
• Devaluation: An official reduction in the value of a currency in a fixed exchange rate system, aimed at enhancing export competitiveness.

FAQs

What is the primary objective of a managed currency?

The main objective is to stabilize the currency’s value and protect the economy from volatile exchange rate movements.

How does a central bank manage a currency's value?

Through open market operations, adjusting interest rates, and direct interventions in the forex market by buying or selling its currency.

What are the risks associated with managed currencies?

Risks include loss of credibility if the system is not sustainable, potential for black-market exchange rates, and economic misalignment due to artificial exchange rate settings.

Can managed currencies lead to inflation?

If not properly managed, they can lead to inflation by creating distortions in the market, such as an oversupply of the local currency.

References

1. Krugman, P., & Obstfeld, M. (2018). International Economics: Theory and Policy. Addison-Wesley.
2. Mishkin, F. S. (2019). The Economics of Money, Banking, and Financial Markets. Pearson.

Summary

Managed currencies represent a strategic approach to controlling a nation’s currency value by governmental or central bank interventions. These systems aim to stabilize economies, control inflation, and balance trade, especially pivotal for emerging and developing markets. Understanding the dynamics of managed currencies provides insights into global economic policies and international finance.