Question

Definition of exchange rate regimes , briefly explain

Answer 1

Ans ) Exchange rate regime

An exchange rate regime is the way a monetary authority of a country or currency union manages the currency in relation to other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many of the same factors, such as economic scale and openness, inflation rate, elasticity of the labor market, financial market development, capital mobility etc.

There are two major regime types:

• fixed (or pegged) exchange rate regimes, where the currency is tied to another currency, mostly reserve currencies such as the U.S. dollar, euro, British Pound Sterling or a basket of currencies, or
• floating (or flexible) exchange rate regimes, where the economy dictates movements in the exchange rate.

There are also intermediate exchange rate regimes that combine elements of the other regimes.

Intermediate rate regime :

The exchange rate regimes between the fixed ones and the floating ones.

Band

There is only a tiny variation around the fixed exchange rate against another currency, well within plus or minus 2%.

For example, Denmark has fixed its exchange rate against the euro, keeping it very close to 7.44 krone = 1 euro (0.134 euro = 1 krone).

Crawling peg

A crawling peg is when a currency steadily depreciates or appreciates at an almost constant rate against another currency, with the exchange rate following a simple trend.

Currency basket peg

A currency basket is a portfolio of selected currencies with different weightings. The currency basket peg is commonly used to minimize the risk of currency fluctuations. For example, Kuwait shifted the peg based on a currency basket consists of currencies of its major trade and financial partners.

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