Managed exchange rates
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:
- 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.
Go to an exchange rate site (try Oanda.com) or statistics site and find exchange rates for the last couple of years for the country where you are, against one of the major worldwide currencies (e.g. the euro, dollar or sterling). Plot these figures and assess what impact the changes are likely to have had on the balance of payments on current account.
Then, find out the figures for the current account and see if your expectations were correct. Identify other factors that may have been responsible for the balance of payments changes.
Identity the type of exchange rate system operating in your country. If it is a fixed rate system, find out the level of the fixed rate and any revaluations and devaluations there may have been. If the exchange rate is a floating system find figures for the exchange rate against three major currencies for the last 10 years and plot the figures on a graph. Mark on the graph the years where there have been a depreciation in the rate, and the years where there have been an appreciation in the rate.