What Is Adjustment?

An adjustment is the use of mechanisms by a central bank to influence a home currency's exchange rate. An adjustment is specifically made if the exchange rate is not pegged to another currency, meaning that the currency is valued according to a floating exchange rate.

Because the central bank intervenes in the home currency's exchange rate to reduce short-term fluctuations, this is considered a managed floating exchange rate.

Adjustment may also refer to a fee charged by U.S. international shippers to cover potential losses from exchange rate volatility involved in international trade. The term may also be used in reference to variable-rate mortgages, where the rate is adjusted periodically, as in the case of ARMs. The adjustment frequency would set this period, for example with a 5/1 ARM, the first five years are fixed but then have a variable rate that adjusts annually.

Key Takeaways

  • Adjustment, in monetary policy, refers to central bank actions that influence the foreign exchange rate of the domestic currency.
  • This may be done, for instance, to weaken a country's currency if it has strengthened substantially and has hurt exporters.
  • U.S. international shippers may also use the term adjustment to describe the currency adjustment factor, or CAF, which is a surcharge added to cover exchange rate fluctuations between foreign trade partners.

Understanding Adjustment

Central banks may become involved in adjustment if they believe that movements in the home currency are too "extreme," especially since a rapid increase or decrease in a currency's value can lead to significant effects on its economy.

Inconsistent adjustment policies in terms of an exchange rate mechanism (ERM) result in uncertainty on the part of investors and is referred to as a "dirty" managed exchange rate policy.

Currency Adjustment Factor

Another application of adjustment happens in the shipping industry, where shippers charge the Currency Adjustment Factor (CAF) surcharge to account for the volatility in currency exchange rates. The "CAF," as it may appear on a shipping invoice, varies according to the destination country. For example, if the "basic ocean freight" rate for a particular shipment to, say, Peru is $15,000 and the CAF rate for Peru is 6 percent, then the CAF for the shipment will be $900. The rates are designed to even out fluctuations in exchange rates. Sometimes, the CAF will provide more money than the shipper really needs, sometimes less.

For American shippers, the currency adjustment factor rises as the value of the U.S. dollar falls. It is applied as a percentage on top of the base exchange rate, which is calculated as the average exchange rate for the previous three months. Due to this added charge, shippers are now looking to enter into "all-inclusive" contracts at one price, that accounts for all applicable charges, to limit the effect of the CAF.

The CAF was established to deal with volatile fluctuations between the exchange rates of Pacific Rim countries and U.S. exporters, which led to currency losses for shippers. The CAF was imposed as a sort of insurance to cover the potential for such future losses.