4.4 Managed floating

4.4 Managed floating

Since the advent of floating exchange rates in 1973 it has become evident that authorities have not always let their currency float freely, but rather they have frequently intervened to influence the exchange rate.A number of rationales have been put forward to justify such intervention and are worth consideration.

Before examining some of the most frequently used arguments for intervention, it is necessary to assume that the authorities can influence the nominal and/or real exchange rate in their desired direction; without such an assumption no rationale for intervention can exist.Further, when assessing the validity of intervention policy it is necessary to compare exchange market intervention with alternative policies.Only if it can be demonstrated that intervention has a superior benefit to cost impact to other policies, or that constrains prevent the use of superior policies, can exchange market intervention be justified.Throughout, it should be remembered that exchange-rate management by the authorities can vary in degree from occasional intervention to influence the exchange rate to a permanent pegging.

The arguments for some degree of discretionary intervention overlap to some extent, but fall into three main categories:

1.The authorities can choose an exchange rate more in line with economic fundamentals than the market;

2.Intervention is required to mitigate the costs of exchange-rate “over shooting”; and

3.Intervention is an appropriate instrument for smoothing necessary economic adjustments.