What Is a Managed Currency?
A managed currency is one whose value and exchange rate are influenced by some intervention from a central bank. This may mean that the central bank increases, decreases, or maintains a steady value, sometimes linked to another currency.
- A managed currency is one where a nation's government or central bank intervenes and influences its value or buying power on the market, especially in foreign exchange markets.
- Central banks manage currency by 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.
Understanding Managed Currencies
Currency is the current liability and demand instrument of a financial institution or government, which takes the form of accounting credits and paper notes that may circulate as a generally accepted substitute for money and may be legally designated as the legal tender in a country. A central bank, government treasury, or other monetary authority manages a currency, and is typically given free control over the production and domestic distribution of the money and credit for a country. In this sense, all currencies are managed currencies with respect to their domestic supply and circulation, with the ostensible goals of price stability and economic growth.
A central bank may also specifically intervene in foreign currency exchange markets to manage a currency's exchange rate in the global market. In general, all currencies are also managed currencies in this sense as well, in that the currency manager is the one who chooses to either float their currency or actively intervene in the exchange markets. In colloquial use among traders, the degree to which the currency issuer actually chooses to actively intervene determines whether a currency is considered a managed currency or not at any given point in time.
This degree of active management determines whether the currency has a fixed or floating exchange rate. Most currencies today are nominally free-floating on the market versus one another, but central banks will step in when they judge it useful 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 that is maintained through continuous, active management versus other currencies.
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 four general categories as follows:
- Issuing currency and setting interest rates on loans and bonds to control growth, employment, consumer spending, and inflation,
- Regulating member banks through capital or reserve requirements and providing loans and services for a nation’s banks and its government,
- Serving as an emergency lender to distressed commercial banks and sometimes even the government by purchasing government debt obligations,
- Buying and selling securities in the open market, including other currencies.
Other techniques to manipulate currency values and exchange rates may be used, such as direct currency or capital controls. New ones are often being developed, which are collectively known as unconventional or non-standard monetary policy. Central banks intervene in the value of their currencies via activist monetary policy to influence domestic price inflation rates and their nations' GDP and unemployment rates, which also affect their value in foreign exchange.
These actions raise or lower the market value of currencies, in terms of other currencies or in terms of real goods and services, by altering the supply available on the market. Managing the market value of their currencies (or their inverse—price levels) in both domestic markets and foreign exchange is generally understood to be a primary responsibility of monetary authorities.
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 market demand for the currencies' foreign exchange. 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 market price, or for an options forward delivery contract for future delivery.
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 in the forex market and will be the spot price.
When currency price changes happen solely because of domestic money supply and demand interacting with foreign exchange demand, it is known as a clean float or a pure exchange. Virtually no currencies genuinely fall into the clean float category. All of the major world currencies are managed, at least to some extent. Managed currencies include, but are not limited to the U.S. 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 to 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 loosened this policy in 2005 in favor of a form of managed floating currency system, where the value of the currency is allowed to float within a selected range.
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.
A country may control its currency, for example, 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 its own or other currencies.
In some cases, the central bank of one government may step in to help manage the currency of a foreign power. In 1995, for instance, 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 to lose value rapidly.