What is a Clean Float
A clean float, also known as a pure exchange rate, occurs when the value of a currency, or its exchange rate, is determined purely by supply and demand. The float is money in the banking system that is briefly counted twice due to delays in processing checks and can distort the money supply for the nation.
BREAKING DOWN Clean Float
Most of the world’s currencies exist as part of a floating exchange rate regime. In this system, currency values fluctuate in response to movements in foreign exchange markets. You may have noticed that when you travel to the Eurozone, for example, the amount of euros you can exchange for your dollars varies from trip to trip. This variation is a result of the fluctuations in the foreign exchange markets. Floating currencies sit in contrast with fixed money, which has a value basis on the current market value of gold or another commodity. Floating currencies may also float in their relation to another currency or basket of currencies. China was the last country to use the fixed currency, giving it up in 2005 for a managed currency system.
Clean floats exist where there is no government interference in the exchange of currency. Clean floats are a result of laissez-faire or free market economics where government places few restrictions on buyers and seller. A clean float is the opposite of a dirty float, which occurs when government rules or laws affect the pricing of currency.
Limitations of Clean Floats
In a perfect world, clean floats mean the value of currencies automatically adjusts, leaving countries free to pursue internal monetary goals such as controlling inflation or unemployment. However, a clean floating currency can be susceptible to external shocks, such as a spike in the price of oil, which can make it hard for countries to maintain a clean floating system.
That’s why many of the world’s currencies, are only floating to a certain extent and rely on some support from their corresponding central bank. These limited extent floating currencies include the US dollar, the euro, the Japanese yen and the British pound.
Most countries intervene from time to time to influence the price of their currency in what is known as a managed float system. For example, a central bank might let its currency float between an upper and lower price boundary. If the price moves beyond these limits, the central bank may buy or sell large lots of currency in an attempt to rein in the price. Canada maintains a system that most closely resembles a genuine floating currency. The Canadian Central Bank has not intervened with the price of the Canadian dollar since 1998. The US also interferes relatively little with the price of the American dollar.