Exchange-rate Flexibility

Exchange-rate Flexibility

A flexible exchange-rate system is a monetary system that allows the exchange rate to be determined by supply and demand.

Every currency area must decide what type of exchange rate arrangement to maintain. Between permanently fixed and completely flexible however, are heterogeneous approaches. They have different implications for the extent to which national authorities participate in foreign exchange markets. According to their degree of flexibility, post-Bretton Woods-exchange rate regimes are arranged into three categories: currency unions, dollarized regimes, currency boards and conventional currency pegs are described as “fixed-rate regimes”; Horizontal bands, crawling pegs and crawling bands are grouped into “intermediate regimes”; Managed and independent floats are described as flexible regimes. All monetary regimes except for the permanently fixed regime experience the time inconsistency problem and exchange rate volatility, albeit to different degrees.