Key Takeaways
- Managed currencies are influenced by central banks to maintain or adjust their value.
- Central banks intervene in foreign exchange markets to stabilize currency rates.
- Most modern currencies are managed to some extent, although many are nominally free-floating.
- Currency management includes issuing currency, setting interest rates, and managing reserves.
- Managed currencies help stabilize markets and reduce volatility and uncertainty.
What Is a Managed Currency?
A managed currency is one whose value and exchange rate are influenced by the intervention of a central bank. This might involve increasing, decreasing, or maintaining a steady value, sometimes linked to another currency.
Understanding how managed currencies function is key for both investors and governments, since they impact economic stability and international trade dynamics.
By issuing currency, setting interest rates, and managing foreign reserves, central banks can significantly affect a nation’s economic and financial landscape.
Most global currencies, such as the U.S. dollar, European Union euro, British pound, and Japanese yen, are managed to varying degrees through interventions in the foreign exchange market.
How Central Banks Influence Currency Values
Currency is the current liability and demand instrument of a financial institution or government, which takes the form of accounting credits and paper notes that may circulate as a generally accepted substitute for money and may be legally designated as the legal tender in a country. A central bank, government treasury, or other monetary authority manages a currency and is typically given free control over the production and domestic distribution of the money and credit for a country. In this sense, all currencies are managed currencies with respect to their domestic supply and circulation, with the ostensible goals of price stability and economic growth.
A central bank may also specifically intervene in foreign currency exchange markets to manage a currency’s exchange rate in the global market. In general, all currencies are also managed currencies in this sense as well, in that the currency manager is the one who chooses to either float their currency or actively intervene in the exchange markets. In colloquial use among traders, the degree to which the currency issuer actually chooses to actively intervene determines whether a currency is considered a managed currency or not at any given point in time.
This degree of active management determines whether the currency has a fixed or floating exchange rate. Most currencies today are nominally free-floating on the market vs. one another, but central banks will step in when they judge it useful to support or weaken a currency if the market price falls or rises too much in relation to other currencies. In the most extreme cases, managed currencies may have a fixed or pegged exchange rate that is maintained through continuous, active management vs. other currencies.
Mechanisms of Currency Management
Central banks manage a nation’s currency through the use of monetary policies, which range widely depending on the country. These economic policies usually fall into four general categories:
- Issuing currency and setting interest rates on loans and bonds to control growth, employment, consumer spending, and inflation
- Regulating member banks through capital or reserve requirements and providing loans and services for a nation’s banks and its government
- Serving as an emergency lender to distressed commercial banks and sometimes even the government by purchasing government debt obligations
- Buying and selling securities in the open market, including other currencies
Other techniques to manipulate currency values and exchange rates may be used, such as direct currency or capital controls. New ones are often being developed, which are collectively known as unconventional or nonstandard monetary policy. Central banks intervene in the value of their currencies via activist monetary policy to influence domestic price inflation rates and their nations’ gross domestic product (GDP) and unemployment rates, which also affect their value in foreign exchange.
These actions raise or lower the market value of currencies, in terms of other currencies or in terms of real goods and services, by altering the supply available on the market. Managing the market value of their currencies (or their inverse—price levels) in both domestic markets and foreign exchange is generally understood to be a primary responsibility of monetary authorities.
Different Approaches to Managing Currency
Most of the world’s currencies participate to some degree in a floating currency exchange system. In a floating system, the prices of currencies move relative to one another based on market demand for the currencies’ foreign exchange. The global foreign exchange market, known as the forex (FX), is the largest and most liquid financial market in the world, with average daily volumes in the trillions of dollars. The currency exchange transactions can be for the spot price, which is the current market price, or for an options forward delivery contract for future delivery.
Tip
When you travel to foreign countries, the amount of foreign money you can exchange your dollar for at a currency kiosk or bank will vary depending on the fluctuations in the forex market and will be the spot price.
When currency price changes happen solely because of domestic money supply and demand interacting with foreign exchange demand, it is known as a clean float or a pure exchange. Virtually no currencies genuinely fall into the clean float category. All of the major world currencies are managed, at least to some extent. Managed currencies include, but are not limited to, the U.S. dollar, the European Union euro, the British pound, and the Japanese yen. However, the degree to which nations’ central banks intervene varies.
In a fixed currency exchange, the government or central bank pegs the rate to a commodity, such as gold, or to another currency or a basket of currencies to keep its value within a narrow band and provide greater certainty for exporters and importers. The Chinese yuan was the last significant currency to use a fixed system. China loosened this policy in 2005 in favor of a form of managed floating currency system, where the value of the currency is allowed to float within a selected range.
Benefits and Reasons for Managing a Currency
A genuine floating currency exchange can experience a certain amount of volatility and uncertainty. For example, external forces beyond government control, such as the price of commodities, like oil, can influence currency prices. A government will intervene to exert control over its monetary policies, stabilize its markets, and limit some of this uncertainty.
A country may control its currency, for example, by allowing it to fluctuate between a set of upper and lower bounds. When the price of money moves outside of these limits, the country’s central bank may purchase or sell its own or other currencies.
In some cases, the central bank of one government may step in to help manage the currency of a foreign power. In 1995, for instance, the U.S. government bought large quantities of Mexican pesos to help boost that currency and avert an economic crisis when the Mexican peso began to lose value rapidly.
The Bottom Line
A managed currency is one with a value and exchange rate that are influenced by central bank intervention.
Central banks manage currency through monetary policies, such as issuing currency, setting interest rates, regulating banks, and intervening in foreign exchange markets.
Most currencies are managed to some extent, with either a fixed (set and maintained by the central bank) or floating (determined by the private market through supply and demand) exchange rate.
Key reasons for currency management are the stabilization of markets and the reduction of volatility.
A historical example of currency management is when the U.S. government bought large quantities of Mexican pesos in 1995. That action supported the Mexican currency and averted an economic crisis.
