NCPA - National Center for Policy Analysis

Floating Currencies, Or Fixed Exchange Rates?

July 20, 2001

Floating exchange rates let the free market determine the value of a currency as compared to another. Fixed exchange rates are political mechanisms "freezing" the value of a currency as compared to another. According to the International Monetary Fund (IMF), only 11 percent of countries had pegged exchange rates in 1999, down from 97 percent in 1970. While this suggests an increase in floating rates, a recent article argues that governments are merely claiming to use floating rates.

The research covers 154 exchange rate arrangements in 39 countries during the 1970-99 period. The evidence is that many governments claim to have floating exchange rates, but do not actually use them:

  • The United States and Japan (two true floating countries) fluctuated within a 2.5 percent band of values only 60 percent of the time.
  • In contrast, Bolivia and India fluctuated within the 2.5 percent band as high as 93 to 94 percent of the time -- indicating monetary authorities aimed to keep the ratio of the currencies' values fixed.

The article breaks down the different regimes into categories by their different fluctuation rates within a 2.5 percent band:

  • "True floaters" fluctuated almost 80 percent of the time
  • "Managed floaters" fluctuated 88 percent of the time
  • "Limited flexibility" regimes fluctuated 92 percent of the time
  • "Fixed exchange rate regimes" fluctuated 96 percent of the time.

The lack of floating has serious implications in the interest rate market:

  • Floaters and managed floaters' interest rates have a 47 to 49 percent chance of moving within a 0.5 percent range in any given month.
  • The United States and Japan had an 81 to 86 percent chance of such movement, a significantly higher value.

The authors argue that while more regimes may claim to be floating regimes, they are keeping fixed regimes by limiting the fluctuations allowed by political mechanisms.

Source: "Fear of Floating," Economic Intuition, Winter 2001; based on Guillermo A. Calvo and Carmen M. Reinhart, "Fear of Floating," National Bureau of Economic Research, Working Paper, No. w7993, November 2000.

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