The Benefits of Free Floating Exchange Rates
The free floating currency system of foreign exchange is the predominant system of exchange, and it’s has now prevailed over other systems. With progressing globalization, more and more countries are ditching their currency pegs and have enabled their currencies to freely float.
Some have been compelled to do so because of market participants, while others have made their choice because of the advantages that the system offers. In this article, we will discuss the advantages that free floating exchange rates bring to a country and market Brokerage Definition.
Market Determined Rates
Free floating exchange rates mean that the market will determine the rate at which one currency can be exchanged for another. The market will determine these rates on a real time basis, as well as whenever new information come in.
This lessens the need for an elaborate mechanism to ensure that the exchange rates stay within a specific range.
Fixed exchange rates require the central banks to set up trading checks, while currency boards are required to manage the currency actively on a daily basis. In case of a floating exchange rate, the central bank does not have to take so much effort.
Rather, it can just passively manage the currency by setting important rates and by interfering in the market only when it becomes necessary Top Financial Brokerage Firm.
Free floating exchange rates enable the governments and central banks of a nation to have a great degree of independence. In case of fixed exchange rates, the central bank of different nations have to act in conjunction with each other.
This is because the monetary policy that they set could influence or be affected by the economic conditions of member nations. For example, when the dollar raises its interest rates, all currencies that are pegged to it also have to make necessary changes.
Therefore, the countries that have their currencies pegged to the US dollar will have limited independence while countries that let their currencies freely float will have a far more independence.
Low Reserve Requirement
A freely floating exchange system doesn’t require the central bank to hold massive reserves. That’s because the bank does not have to perform active trading operations just to maintain the value of the currency.
Central bank operations are a very rare event for countries that have a floating rate system. This is a huge advantage for the system since holding foreign exchange for trading purposes is quite expensive. First, it requires the country to maintain a large currency reserve. Then, it requires the central bank to trade 24/7.
A floating rate system is merely a lot more convenient because it doesn’t have any of those requirements.
Lower Chance for Speculative Attacks
A free floating currency faces adjustment every minute. There are some days that the currency faces speedy appreciation while there are period when it faces rapid slips. However, for most of the days, the currency remains stable.
The point is that speculative attacks take place only when the currency remains stagnant at a given point as its fundamentals have already changed. It is then that the speculators see a chance to bring the currency to its equilibrium point quickly and make a quick income by doing so.
On the other hand, if the currency is traded on the forex market as a free floating currency, adjustments can take place all the time. That means the gap between the underlying fundamentals and the market value never really widens up enough for the speculators to unleash a sudden attack .