Fixed Versus Floating Exchange rate regimes

Fixed exchange rate regime

·         Operations in the forex market are passive in nature.

·         Exchange rates are determined by governments.

·         The set price of the home currency will be determined by comparing it with a major world currency.

·         The central bank buys and sells its own currency to maintain an exchange rate.

Example:

The Thai baht was pegged to the US Dollar. People used to consider it a prized currency investment. After the adverse capital market events of 1996 to 1997, the currency depreciated and Thai baht plunged rapidly because the government was not able to defend its currency by using the limited peg reserves nor was it willing. Later, in 2007, the Thai government had to resort to floating its currency along with accepting a bailout from IMF. The baht had fallen by about 40 percent during the time between July 1997 and October 1997.

Saudi Arabia follows a fixed currency regime. The currency of Saudi Arabia is Saudi Riyal which was pegged against the US Dollar and it was determined by the Saudi Arabian Monetary Agency. During the time between 1960 and 1975, the Saudi government made several changes in their currency rates in order to maintain the gold rates. But in march 1975, an effective rate was introduced and it was linked to SDR and the exchange rate of Saudi Riyal was pegged to SDR at 1 SDR equaling SRL 4.28255. Due to this, the currency was allowed to be floated partially at a margin of 2.25 percent, resulting in the appreciation of the currency.

Floating Exchange rate regime

·         Operations in the forex market are active in nature.

·         Exchange rates are determined by demand and supple factors.

·         Any difference in the demand or supply will automatically change the prices.

·         It is constantly changing.

·         The central bank may also sometimes intervene to stabilize a currency or to avoid inflation.

Example,

Brazil follows a floating exchange rate regime. This regime was adopted by the country in 1990. But this regime was subjected to an adjustable band from the time between 1995 to 1999 to control money creation. As before whenever the inflation in the country got out of hand, it issued a new currency with a different name. Still, during this time period, there was still high inflation. In 1999, Brazil faced major currency crisis and its currency was set to float independently from then on.

The currency of South Korea is Won (W). It was pegged initially to the US Dollar. But, in February 1980, the Won’s fixed pegging to US Dollar was dismissed and the currency was then floated by the country and a floating effective rate implemented. Thailand’s decision to float baht on 2^nd July, 1997 result in depreciation in the value of Won and this forced the government to defend its currency. It did so by first widening the band from 2.25 percent to 10 percent and then abandoning it entirely and floating the currency on 12^th December.