An exchange-rate regime is the way an authority manages its currency in relation to other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many of the same factors, such as economic scale and openness, inflation rate, elasticity of labor market, financial market development, capital mobility and etc.
There are two major regime types: fixed (or pegged) exchange rate regimes，where the currency is tied to another currency, mostly reserve currencies such as the U.S. dollar or the euro or a basket of currencies; floating (or flexible) exchange rate regimes, where the economy dictates movements in the exchange rate. However, the distinctions between fixed and floating exchange rate regimes are not so cut and dried in reality. Thus, there are also the intermediate exchange rate regimes in between.
This classification of exchange rate regime is based on the classification method carried out by GGOW (Ghosh、Guide、Ostry and Wolf, 1995, 1997), which combined the IMF de jure classification with the actual exchange behavior so as to differentiate between official and actual policies. The GGOW classification method is also called Trichotomy Method.
Floating (or flexible) exchange rate regimes are those in which a country's exchange rate fluctuates in a wider range and the government makes no attempt to fix it against any base currency. Appreciations and depreciations may occur from year to year, each month, by the day, or every minute. They can be divided into two types——free float and managed float.
Free float, also known as clean float, signifies that a currency's value is allowed to fluctuate in response to foreign-exchange market mechanisms without government intervention.
Managed float (or dirty float)
Managed float, also known as dirty float, involves government intervention in the market exchange rate in different forms and degrees, in an attempt to make the exchange rate change in a direction conducive to the economic development of the country, especially during an extreme appreciation or depreciation.
A central bank might, for instance, allow a currency price to float freely between an upper and lower bound, a price "ceiling" and "floor."
The exchange rate regimes between the fixed ones and the floating ones.
There is only a tiny variation around the fixed exchange rate against another currency, well within plus or minus 2%.
For example, Denmark has fixed its exchange rate against the euro, keeping it very close to 7.44 krone per euro (0.134 euro per krone).
The currency steadily depreciates or appreciates at an almost constant rate against another currency. And the exchange rate follows a simple trend.
Some variation about the rate is allowed, and adjusted as above.
Currency basket peg
A currency basket is a portfolio of selected currencies with different weightings. The currency basket peg is commonly used to minimize the risk of currency fluctuations. For example, Kuwait shifted the peg based on a currency basket consists of currencies of its major trade and financial partners.
Fixed exchange rate regimes, sometimes called a pegged exchange rate regime, are those in which a country's exchange rate fluctuates in a narrow range (or not at all) against some base currency or to other measure of value over a sustained period, usually a year or longer. A country's exchange rate can remain rigidly fixed for long periods only if the government intervenes in the foreign exchange market in one or both countries.
Currency board is an exchange rate regime in which a country's exchange rate maintain a fixed exchange rate with a foreign currency, based on an explicit legislative commitment. It is a type of fixed regime that has special legal and procedural rules designed to make the peg "harder—that is, more durable." Examples include the Hong Kong dollar against the U.S dollar and Bulgarian lev against the Euro.
Dollarisation, also currency substitution, means a country unilaterally adopts the currency of another country.
Most of the adopting countries are too small to afford the cost of running its own central bank or issuing its own currency. Most of these economies use the U.S dollar, but other popular choices include the euro, and the Australian and New Zealand dollars.
A currency union, also known as monetary union, is an exchange regime where two or more countries use the same currency. Under a currency union (or monetary union), there is some form of transnational structure such as a single central bank or monetary authority that is accountable to the member nations.
Some famous examples of currency union are the Eurozone, CFA and CFP Franc zones. One of the first known examples is the Latin monetary Union set up in the 19th century.
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