Economics · Ch 6 — Open Economy Macroeconomics
Managed Floating
Managed Floating
6.2.4 Managed Floating
The world has moved, without any formal international agreement, to a system best described as managed floating. This is a hybrid — a mixture of a flexible exchange rate system (the "float" part) and a fixed rate system (the "managed" part). Under this arrangement, also called dirty floating, central banks intervene in foreign exchange markets — buying and selling currencies — to moderate exchange rate movements whenever they judge such actions appropriate.
Because the central bank actively buys or sells foreign currency, official reserve transactions are not zero under managed floating. This is the key difference from a pure flexible rate system, where official reserves do not change.
The term "dirty floating" is not a value judgment — it simply describes a float that is not perfectly clean. All major currencies today operate under some form of managed float.
How Intervention Works
Suppose the rupee is depreciating rapidly against the dollar — that is, it takes more rupees to buy one dollar. If the central bank feels this depreciation is excessive or disruptive, it can sell dollars from its foreign exchange reserves and buy rupees. This increases the demand for rupees and the supply of dollars, which slows or reverses the rupee's fall.
Conversely, if the rupee is appreciating too quickly (making Indian exports expensive), the central bank can buy dollars and sell rupees, adding to its reserves while weakening the rupee.
The central bank does not target a specific exchange rate, as it would under a fixed system. Instead, it leans against the wind — smoothing out sharp movements without committing to any particular parity.
Managed floating is not the same as a fixed exchange rate. Under a fixed system, the central bank defends a specific parity. Under managed floating, it merely moderates the rate's movement. The difference is one of degree, not kind — but it is an important conceptual distinction.
Why "Managed"?
The rationale for management is that completely free floats can produce excessive volatility — exchange rates may overshoot their long-run equilibrium values, creating uncertainty for trade and investment. By intervening occasionally, central banks can reduce this volatility without sacrificing the flexibility that allows the exchange rate to act as a shock absorber.
At the same time, managed floating avoids the problems of fixed rates: the need to hold very large reserves, the vulnerability to speculative attacks, and the loss of independent monetary policy. …