Question

Describe what is meant by "currency regimes" and define the selected types of regimes available. What is the currency regime for The Kingdom of the Netherlands?

Answer 1

A currency regime (or exchange rate regime) is the way a country manages its currency in respect to foreign currencies and the foreign exchange market. The Government uses this method in order to administer the domestic currency in the context of the other major currencies of the world.

There are two extreme currency regimes available: Fixed exchange rate and Floating exchange rate.

Fixed Exchange Rate

Under this system, the government or the central bank intervenes in the foreign exchange market so that the exchange rate is maintained at the target exchange rate. The government intervenes in the foreign exchange market, through the process of buying and selling of foreign assets/currencies. This method enables the central bank to keep the exchange rate at the target fixed level.

Floating Exchange Rate

Under this system, the value of the currency is influenced by the movements in the financial markets. It is also known as dirty float or managed float because the government always intervenes in the foreign exchange market to arrest excessive volatility in foreign exchange rates. The floating rates are extensively used in most countries of the world.

Under floating exchange rate, the currency can operate under:

Free floating exchange rate- Under the free floating regime, the value of currency is determined by market demand for and supply of the currency. Trade flows and capital flows are the main factors affecting the exchange rate.

Managed floating exchange rate- Under the managed floating regime, though exchange rate is determined by market forces of demand and supply, the central bank or the government sets the target exchange rate to protect their exports/import. The central bank thus regularly intervenes in the foreign exchange market to prevent any kind of excessive volatility or divergence from the target rate.

Currency Regime in the Netherlands

The official currency in the Netherlands is the Euro (EUR). The European Central Bank (ECB) is responsible for monetary policy, and it is an autonomous institution. The Eurozone has never imposed exchange controls since the introduction of the Euro. There are no restrictions to hold foreign currency in the Netherlands, though foreign currency products are rarely sold by Dutch banks.

The Euro follows a purely freely floating exchange rate regime as there is no official exchange rate target. The central bank may rarely intervene in foreign exchange markets. Here, the Euro is used as a world currency. Many other countries peg their currencies to the Euro which includes Denmark, Morocco, many Eastern European countries, and most French-speaking Sub-Saharan countries.