What Is a Managed Currency?
A managed currency is one whose price and exchange rate are influenced by some intervention from a central bank. Currency is a generally accepted form of money, including coins and paper notes, which is issued by a government and circulated within an economy. A central bank or monetary authority is the manager of money and often a nationalized institution that is given free control over the production and distribution of the money and credit for a country.
A central bank may also intervene in currency markets to manage a currency's exchange rate in the market. Most currencies today are free-floating on the market versus one another, and so a central bank may step in to support or weaken a currency if the market price falls or rises too much in relation to other currencies. In the most extreme cases, managed currencies may have a fixed or pegged exchange rate versus another currency, such as the U.S. dollar.
- A managed currency is one where a nation's government or central bank intervenes and influences its exchange rate or buying power on the market.
- Central banks manage currency through issuing new currency, setting interest rates, and managing foreign currency reserves.
- Monetary authorities also manage currencies on the open market to weaken or strengthen the exchange rate if the market price rises or falls too rapidly.
- A completely unmanaged currency is said to be a 'free-float', although very few such currencies exist in practice.
How a Managed Currency Works
Central banks manage a nation's currency through the use of monetary policies which range widely depending on their country. These economic policies usually fall into three general categories.
- Issuing currency and setting interest rates on loans and bonds to control growth, employment, consumer spending, and inflation
- Regulate member banks through capital or reserve requirements and provide loans and services for a nation’s banks and its government
- Behaves as an emergency lender to distressed commercial banks, and sometimes even the government by purchasing government debt obligations
- Operates in the open market to buy and sell securities, including other currencies.
Types of Currency Management
Most of the world’s currencies participate to some degree in a floating currency exchange system. In a floating system, the prices of currencies move relative to one another based on external foreign exchange market forces. The global foreign exchange market, known as the forex (FX), is the largest and the most liquid financial market in the world, with average daily volumes in the trillions of dollars. The currency exchange transactions can be for the spot price, which is the current marketplace cost, or for an options forward delivery contract for future delivery. For example, when you travel to foreign countries, the amount of foreign money you can exchange your dollar for at a currency kiosk or bank will vary depending on the fluctuations taking place in this market and will be the spot price.
When currency price changes happen without any outside government influence or intervention by central banks, it is known as a clean float or a pure exchange. A clean float is a product of free economics, or laissez-faire economics, where price is determined solely by the forces of supply and demand in the world market.
Virtually no currencies genuinely fall into the clean float category. Most of the major world currencies are managed at least to some extent. Managed currencies include, but are not limited to the US dollar, the European Union euro, the British pound, and the Japanese yen. However, the degree to which nations’ central banks intervene varies.
In a fixed currency exchange the government or central bank pegs the rate to a commodity, such as gold, or another currency or a basket of currencies to keep its value within a narrow band and provide greater certainty for exporters and importers. The Chinese yuan was the last significant currency to use a fixed system. China discontinued this policy in 2005 in favor of a form of the managed currency system.
Why Use Managed Currency?
Genuine floating currency exchange can experience a certain amount of volatility and uncertainty. For example, external forces beyond government control, such as the price of commodities like oil, can influence currency prices. A government will intervene to exert control over their monetary policies, stabilize their markets, and limit some of this uncertainty.
For example, a country may control its currency by allowing it to fluctuate between a set of upper and lower bounds. When the price of the money moves outside of these limits, the country’s central bank may purchase or sell currency.
In some cases, the central bank of one government may step in to help manage the currency of a foreign power. For example, in 1995, the U.S. government bought large quantities of Mexican pesos to help boost that currency and avert an economic crisis when the Mexican peso began rapidly to lose value.