Exchange Rates: Fixed, Flexible, and Managed Float - Video Tutorials & Practice Problems

Exchange Rates: Fixed, Flexible, and Managed Float

Alright, So now let's learn some definitions about exchange rate systems called fixed exchange rate systems and floating exchange rate systems. So, exchange rates, remember this is how we determine how much of a foreign currency we can get with our domestic currency, how many yen we can get with our dollar? How many great british pounds we get with our dollar? How many yen we get with great british pounds, right? These exchange rates. So a floating exchange rate. This is a country that allows its exchange rate to be determined by supply and demand. Okay, So this is generally what happens in most countries is having a sort of floating exchange. We'll talk about something specific below, but a floating exchange rate, it's it's called a flexible exchange rate. So, if you've ever paid attention to exchange rates, if you've traveled to other countries, you'll notice that at any point in time those exchange rates will be different, right? Sometimes you can get more euros per dollar and then less euros per dollar. Right? That exchange rate is changing all the time. And that's because of these floating exchange rates being being uh found by the free market. And this is where we have kind of our supply and demand graph, kind of what we're used to where we have our downward demand and our upward supply, right? And we'll have this equilibrium exchange rate. So let's say we're talking between great british pounds and U. S. Dollars, right? How many pounds per dollar you can get? Well, this would be the equilibrium rate right here, right? And this is our quantity of dollars that we're exchanging here. Well we would have our equilibrium rate rate one. And then we could have shifts in the graph. Right? We can have a shift in the graph. Let me do this in a different color. Maybe maybe the demand increases here and we have a higher demand and we have a new equilibrium rate. So these rates change all the time based on shifts in supply and demand. Right? So the equilibrium rate can increase there. So that's a floating system that supply and demand come into play, compare that to a fixed exchange rate system and this is an agreement between countries to hold exchange rates constant. Okay so we're holding exchange rates constant in a fixed exchange system, fixed system constant right there fixed. Okay, so there was a long time ago we had what was called the Gold standard and that was a fixed exchange rate system. So exchange rates were basically determined by how much gold by the amount of gold each country had if you had more gold while your currency was stronger. However, the gold, the gold standard was abandoned in the 19 thirties, basically during the Great Depression, a lot of countries started to get rid of this standard and allow their currency to fluctuate based on current conditions. However, some countries remained under a fixed system for a long time. One famous example is china china had a fixed exchange rate system for a very long time in very recent years. They've kind of let that go for the most part um But they've had a fixed system um with the U. S. Dollar. So they had what was called pegging. They pegged their currency to the US dollar which means they fixed their currency to another currency. And it's typically the U. S. Dollar. China wasn't the only country that did it. But china is the most recognizable example china pegged its currency to the US dollar for for a long time trading consistently at this price of ¥8.28 per dollar. You don't probably have to remember that number exactly. But you can notice that on this graph this is the exchange rate of yuan yuan yuan per dollar. And look at the exchange rate here, it stayed very constant for a long time, Right? And this is where they were pegging it all throughout these years from 19 around 1995 a little earlier. All the way through 2006 2007. And then you can see they kind of loosened their restrictions. They pegged it again at a different price and you can see it started to be a little more flexible there in more recent years. Okay so that's what pegging is is where you just say hey whatever the U. S. Dollar is, this is our exchange rate compared to that currency. Okay and then we have what's called a managed float and this is somewhere in the middle. So a managed flow is more what what we see in most countries, and this is where the government participates in to help keep a stable uh currency, rather than just letting it fluctuate like crazy. They do still intervene to try and let any huge irregularities from happening, to stop that. So they it's still a floating system, a flexible system with supply and demand at play. But the government will intervene on occasion by buying or selling its own currency. They're gonna affect the supply and demand um by literally getting involved and buying or selling their country their currency. Okay. And that's what most countries uses this managed float system. Um For the most part, they just let it do its thing and then they intervene when they find it necessary. Okay, So that's it. It's just some definitional stuff to remember what a flexible system is. A floating uh fixed system. And then here this managed float. Alright, let's go ahead and move on to the next video