Managed Exchange Rate System

A Managed Floating Exchange Rate System is a system in which a government intervenes at some frequency to change the direction of the float by buying or selling currencies. Often, the local government makes this intervention or It is a system in which the government or the country's central bank occasionally intervenes to change the direction of the value of the countys currency. It is also known as a dirty float, and also can be defined as a readiness to intervene in the foreign exchange market, without defending any particular parity. The governments of different countries including Brazil, Russia, South Korea and Venezuela have imposed bands around their currencies and when they found that they could not maintain the currencys value within the bands they removed the bands.

Methods of Intervention
There are two methods of intervention.

Direct Intervention Indirect Intervention Direct Intervention

In direct intervention if the government of a country wants to put downward pressure on its currency or wants to decrease the value of its currency the government should float its currency in the money market and vice versa. For example, during early 2004, Japans central bank, the Bank of Japan, intervened on several occasions to lower the value of the yen. In the first 2 months of 2004, the Bank of Japan sold yen in the foreign exchange market in exchange for $100 billion. Then, on March 5, 2004 the Bank of Japan sold yen in the foreign exchange market in exchange for $20 billion, which put immediate downward pressure on the value of the yen.

Indirect Intervention
In indirect intervention a country or the central bank can affect the Dollars value indirectly by influencing the factors that determined it. Change in a currencys spot rate is influenced by following factors: e= (INF, INT, INC, GC, EXP) INF = Change in Inflation INT = Change in Interest Rate GC = Change in Government Control EXP = Change in Expectations For example, during Asian crisis in 1997 and 1998, central banks of some Asian countries increased their interest rates to prevent their currencies from weakening. The higher interest

rates were expected to make the local securities more attractive and therefore encourage investors to maintain their holdings of securities, which would reduce the exchange of the local currency for other currencies. This effort was not successful for most Asian countries although it worked for China and Hong Kong.

Managed Exchange Rate System: The Singapore Experience, by Jason Lee, Edward Robinson and Saktiandi Supaat
Since 1981, the monetary policy in Singapore has been centered on management of the exchange rate. The primary objective of this frame works has been to promote price stability as a sound basis for sustainable economic growth. Notably, the framework incorporates several key features of the basket, band and crawl (BBC) regime, as popularized by Williamson (1998, 1999). These may be briefly summarized as follows: First, the Singapore dollar is managed against a basket of currencies of its major trading partners and competitors. The various currencies are assigned different degrees of importance, or weights, depending on the extent of Singapores rate dependence on that particular country. Second, the Monetary Authority of Singapore (MAS) operates a managed float regime for the Singapore dollar. The Trade-weighted exchange rate is allowed to fluctuate within a policy band, the level and slope of which are announced semi-annually to the market. The band provides a mechanism to accommodate sort-term fluctuations in the foreign exchange markets and flexibility in managing the exchange rate. Third, the exchange rate policy band is periodically reviewed to ensure that it maintain that it remains consistent with the underlying fundamentals of the economy. The policy band thus incorporates a Crawl feature, which underscores the importance of continually assessing the path of the exchange rate, so as to avoid misalignments in the currency value. Notably, the assignment of the exchange rate as the intermediate target of monetary policy in Singapore implies that the MAS cede control over domestic interest rates. In the context of free movement of capital, interest rates in Singapore are determined to a large extent by foreign interest rates and investors exceptions of future movements in the S$. Indeed, domestic interest rates have typically been lower than US interest rates, and reflect market expectations of an appreciation of S$. In addition, the relationship between the interest rate and exchange rate in Singapore is generally well-characterized by uncovered interest parity relationship.

Managed Exchange Rate: The Case of the New Taiwan, by Christina Y. Liu
In 1978, the government abandoned the fixed foreign exchange rate system and adopted managed foreign exchange. Under the new system, the foreign exchange rate was determined not by the Central Bank but by the Center of Foreign Exchange, which was composed of five large Taiwanese Banks (namely, the Bank of Taiwan, the Chinese International Commercial Bank, the First Commercial Bank, Hua-Nan Commercial Bank, and Chang-Hua Commercial Bank). A range of 2.25% around the previous days rate was set to prevent violent fluctuations. During the 1980s Taiwans trade surplus increased substantially, and foreign exchange was no longer a scare resource. The government thus replaced the managed foreign exchange rate with a floating rate in 1989.

Foreign exchange policy and intervention in Thailand by Financial Markets Operations Group, Bank of Thailand
Since 2 July 1997, Thailand has adopted a managed-float exchange rate regime, replacing the basket-peg regime which had been in operation since 1984. The value of the baht has since then been largely determined by market forces. The Bank of Thailand manages the exchange rate by intervening in the foreign exchange market from time to time in order to prevent excessive volatilities in the markets, while fundamental trends are accommodated. In other words, movements in the exchange rates which are in line with the changes in economic fundamentals and financial development would only be smoothed and not resisted. The managed-float exchange rate regime together with the inflation targeting framework, which was formally introduced in May 2000 with short-term interest rates as the operating target, has worked well for Thailand. The inflation target performs the role of a new nominal anchor for monetary policy while flexibility in exchange rates helps absorb shocks to the economy. Since the adoption of the managed-float exchange rate regime, the Thai baht has generally moved in line with economic fundamentals. However, extreme exchange rate movements have occasionally occurred due to various causes. As a result, different combinations of techniques and tactics were used depending on the market conditions. Broadly speaking, the Bank of Thailand focuses on containing excessive and persistent exchange rate volatility and intervenes when exchange rate movements appear to be inconsistent with fundamental changes.

The Chilean Case

by Jos De Gregorio y Andrea Tokman R.

Chile is one of the countries that reserved the right to intervene when it adopted the floating regime in 1999. The monetary authority declared that, during exceptional episodes of

uncertainty and volatility, under which there may be adverse economic effects of an over reacting exchange rate, it is desirable that the Central Bank intervene in the exchange rate market.Two such episodes occurred in 2001 and 2002, where the Central Bank, motivated by excessive volatility of the international financial markets and the potentially adverse effects, announced a package of intervention measures to provide more liquidity and foreign currency coverage. The first episode coincided with financial turmoil stemming from the convertibility crisis in Argentina, aggravated by September-11, and the second with turbulence in Brazil during the presidential elections of 2002. In both cases, there were clear indications that exchange rate depreciation was excessive given the evolution of fundamentals. Chiles trade and financial links with Argentina and with Brazil are small. For example, trade with both countries combined is less than 20% of overall Chilean trade. The sharp depreciations clearly indicated that the market had lost its anchor, and hence they could have had adverse effects on inflation that would have required tightening monetary policy in a period in which the economy was growing slowly and thus there were no inflationary pressures. Then, the intervention was seen as a first line of defense to inflation coming from excessive depreciation. The chance that a bubble would have dominated the market would require actions to verify whether this was truly an overreaction. If the Central Bank had not intervened, the excess depreciation, more than that required for adjusting the real exchange rate, would have resulted in inflation to undo the real effects of the nominal depreciation. Indeed, it is likely that a depreciation that pushes the real exchange rate above its equilibrium level will bring inflation. This inflation, in turn, will validate an initially excessive depreciation. Before tightening monetary policy or giving up with inflation it could be advisable to intervene. This intervention does not pursue a particular level of the exchange rate, but rather to avoid an excessive weakening of the currency. If intervention is not effective, it is an indication that exchange rate movements could be the result of a need for a real depreciation. Given this reason for intervention, it has to last for a limited period, and must be oriented at providing liquidity and reestablish and orderly working of the forex market, rather than looking for a particular level for the exchange rate or to reduce fluctuations. The purpose of the intervention is to prevent a rapid depreciation. The success of sterilized interventions in Chile showed that indeed the market reactions were unfounded. Otherwise, intervention would have been ineffective, calling for monetary tightening if inflation expectations had been inconsistent with the target. The first intervention started on August 16th 2001, when the Central Bank communicated that spot market interventions could occur up to a maximum of US$2 billion, over the following four months. Additional sales for US$2 billion of dollar-denominated central bank bills (BCD) were also announced.10 During the period, spot market interventions totaled US$803 million, less than half the maximum announced, which represented nearly 5% of the total stock of international reserves. The spot trades of foreign exchange were done in 15 interventions (15% of working days), and were substantially smaller than in the interventions during the crawling peg period, and less than half the amount exchanged during the unsterilized intervention to defend the peso in 1998. The sale of BCDs, summed up to US$3.04 billion, including the BCDs that were part of the regular program of rollover. These were more frequent than interventions in the spot market and even than sales of BCDs in previous intervention periods. The amount above the regular program of BCDs sales was US$2.3 billion, which led to total intervention of

US$3.1 billion. During that time, the exchange rate appreciated 3.9% (partly reversing the depreciation observed until August), although it had accumulated a depreciation of nearly 5% in September. The maximum daily devaluation was 2.8% (September), and the maximum appreciation in one day was 1.8%, in October. On October 10th of 2002, the Central Bank announced a period of interventions very much like that of 2001, 2 billion dollars in spot and 2 billion dollars in BCDs, to end on February 10th of 2003. This intervention occurred with the Brazilian country risk rate climbing and a complex global scenario. The peso/dollar exchange rate depreciated 7% in one month, showing an accelerating trend, and without similar deterioration in fundamentals, except for turmoil coming from Brazil. Thus, these developments suggested that the exchange rate depreciated more as a result of contagion than of fundamentals. Contrary to the previous experience, however, the Central Bank actually did not intervene in the spot market. However, there were interventions issuing dollar denominated debt. Furthermore, in December 2002, the Governor of the Central Bank announced the possibility of redefining the intervention strategy of the second half of the intervention period. A few days later, the BCD sale calendar was cut to half. Five hundred million US dollars in BCDs were sold in each of the first two months, October and November. Subsequently, the Central Bank considered that a milder intervention would suffice, and sold 250 million in each of the following months, December and January. Total intervention in this episode was 1.5 billion dollars, without spot interventions. This episode involved much less intervention than the first one. Reserves did not change and the total stock of BCDs increased to US$5.8 billion. During this second episode, the exchange rate appreciated by 2.1% (partly reversing the previous depreciation), although by mid December it had appreciated by 8.8%, to relapse in the following months. The biggest depreciation in one day was 1.3% and a 2.3% appreciation occurred the day after the intervention announcement. During the second episode, the exchange rate gradually approached its initial level (figure 2). The intervention was prompted by unusual increases in spreads in Brazil and emerging markets, but after the announcement that intervention would soften because financial turmoil in emerging markets was diminishing, the exchange rate began depreciating again and at a slower pace than the one that triggered the interventions (August-October). This episode shows, first, that the purpose of the interventions was not to target a specific level for the exchange rate, but rather to reduce the speed of depreciation. And, second, that the reaction of the Central Bank was based on turmoil in financial markets rather than, again, on the exchange rate reaching a certain level.

Q. Why do you think Central Banks might prefer a managed exchange rate system over a fixed or a floating exchange rate? A. Managed exchange rate systems permit the government to place some influence on an exchange rate that would otherwise be freely floating. Managed means the exchange rate system has attributes of both systems. On one hand allowing one's currency to be dictated in its

entirety by a foreign nation would be undesirable since exogenous shocks from the pegged country would affect your currency. There would be little control of the Central Bank to change expectations or impact the economy through a change in the exchange rate (thus impact interest rates through supply and demand for domestic currency) as the entire exchange system would be dependent on the foreign nation's policies. The central bank will also be in a position to utilize monetary policy to its advantage, or essentially, the changes in monetary policy will have their desired effect on a market where the exchange is not fixed. Canada uses a managed exchange rate. they do not peg to the USD, and in fact permit the exchange rate to float so long as it remains with a certain target (which varies). If the CB doesn't like how much the dollar declines they can put in place measures to slow a depreciation or appreciation. However, the central banks power to change the exchange rate trend through the markets is usually limited as their influence cannot match the overall buying power of the global market.

Conclusion
A country needs to use Managed Float Exchange Rate System when it has a huge amount of local or foreign currencies available to use more preferably when there is a coordinated effort among central banks who simultaneously attempt to strengthen or weaken the currency in order to maintain the exchange rate at a reasonable point or to make their Managed Exchange Rate policy more affective.