Definition
Floating Exchange Rate
A floating exchange rate is determined freely by currency-market supply and demand, with little or no central-bank intervention to fix its level.
Major currencies like the US dollar, euro, yen and pound float freely, with rates set by global trading. A pure float lets the exchange rate absorb economic shocks automatically and gives the central bank full control over domestic interest rates.
The rupee is best described as a managed float rather than a pure float, since the RBI intervenes to limit volatility. Free floating removes the need to hold large reserves to defend a level but exposes trade to currency swings.
Related terms
- Appreciation vs DepreciationAppreciation is a market-driven rise in a currency's value and depreciation a fall, both occurring under a floating regime, as opposed to deliberate revaluation or devaluation.
- Managed FloatA managed float, or dirty float, is a regime where the exchange rate is largely market-determined but the central bank intervenes to curb excessive volatility.
- Trilemma (Impossible Trinity)The impossible trinity states that a country cannot simultaneously have a fixed exchange rate, free capital movement and an independent monetary policy; it can pick only two.
- Currency PegA currency peg fixes a currency's exchange rate to another currency or basket, requiring the central bank to buy or sell reserves to defend the chosen level.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.