Revision: Floating Exchange Rates

Since 1992 the UK has operated with a floating exchange rate – the external value of the currency has been left to market forces i.e. the supply and demand for sterling in the global foreign exchange markets. In a pure floating system, there is official target for the exchange rate and there is no need for intervention in the currency market by the central bank. The two page revision noteis available below

Countries have always faced constraints in choosing their exchange rate regime.

Any country can have only two out of the following three:

1. An independent monetary policy (freedom to set interest rates)

2. A fixed exchange rate (currency stability and predictability)

3. An open capital account (freedom to finance a current account deficit)

As international financial markets have developed, there has been a general movement to flexible exchange rates supported by credible domestic monetary policies. That is a sensible use of the price mechanism to respond to complex and unpredictable shocks.

The floating exchange rate system has suited the UK well – we are an open economy with a large current account deficit and need the flexibility that a market determined currency provides

Revision note on floating exchange rates
Revision_Floating_Exchange_Rates.pdf