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Managed exchange rates

Syllabus: Explain how a managed exchange rate operates, with reference to the fact that there is a periodic government intervention to influence the value of an exchange rate.

Under the managed exchange rate system, the exchange rate is predominantly determined in the foreign exchange market by supply of and demand for a currency. The government intervenes only occasionally to influence the exchange rate when it considers it to be necessary.

There has been a reduction in central bank intervention in the developed countries over the last decade. However, any central bank still has the discretion to intervene if it feels conditions warrant. The central banks in many parts of the developing world still engage in intervention.

 A recent example of a central bank's intervention on the foreign exchange market is Bank of Japan selling the yen after it spiked dramatically in the aftermath of the 2011 earthquake and tsunami. Moreover, in a show of sympathy the G7 countries joined the Bank of Japan in selling the yen.

Exchange rates are best when they are:

  • Predictable
  • Consistent
  • Not open to 'outside' interference by speculators

Remember that a change in the exchange rate will cause changes in the prices of imports and exports. An increase in the exchange rate will cause export prices to rise and import prices to fall, while a decrease in the exchange rate will cause export prices to fall, but import prices to rise.

Letīs do Some Economics

Thinking time: Here is the 5 year Dollar/Real exchange rate. Note that in 2011 it almost reached parity then climbed steadily until in early 2016 it reached $1=R$4 and then fell back again.

The media tend to focus on one currency (the dollar or the real) but the relationship is 2 way street. If the dollar appreciates the the real must be depreciating and vice versa.

So would you explain the steady rise in the dollar/real exchange rate in terms of the  dollar falling or the real rising? What are the contributing factors that caused this, Brazilian or American explanations?

What accounts for the fall in the real from its peak in early 2016?

The steady growth from 2011 to the end of 2014 shows little volatility. Do you think the Brazilian government was managing this to reduce volatility? Why would they want to do this?