Exchange regime

The exchange regime is a set of policies adopted by a country regarding the value of the currency. Three types of exchange regimes are distinguished according to their flexibility: fixed exchange rate, fluctuation bands and mobile exchange rates. The aforementioned policies are implemented through the central banks.

The concept is not applicable to countries that do not have their own currency, such as Ecuador, Zimbabwe or Vatican City. In the European Union, member countries do not have the power to individually modify the exchange regime, which is administered regionally by the European Central Bank (ECB).

Types of exchange rate regimes

No national legal tender

Situation in which the only legal tender is from another country, or the member country belonging to a monetary union. In this regime, the country renounces monetary control, since the national monetary authorities are excluded when making decisions regarding independent monetary policies.

Currency Box

In the currency board, the exchange regime is based on a legislative commitment by which the national currency must be exchanged for a specific foreign currency at a determined exchange rate. For this purpose, the issuing authorities accept certain restrictions that allow them to comply with their legal obligation. This implies that only foreign-currency-backed domestic currency will be issued and that it will be fully backed by external assets, eliminating traditional central bank functions such as monetary control and lender-of-last-resort, leaving little room for maneuver to apply discretionary monetary policy. Similarly, you can have a certain degree of maneuver according to the rigidity of the set of rules that govern the conversion box.

Other fixed exchange rate

In a fixed or convertible exchange regime, the country links its currency (formally or de facto), to a fixed exchange rate, to an important currency or a Basket of currencies; the weighted value is determined taking into account the value of the currencies of the main trading or financial partners. In a fixed exchange rate regime, the exchange rate fluctuates within a range of less than +/-1% around a formal or de facto central rate. The monetary authority is willing to keep the exchange rate fixed through intervention, which limits the degree of discretion of monetary policy; notwithstanding, the degree of flexibility of monetary policy is greater than in a currency board regime or in monetary unions, since the central bank can still fulfill its traditional functions, albeit with limited scope, and the monetary authority can adjust the level of the exchange rate, albeit infrequently.

Fixed exchange rates within horizontal bands

In these regimes, the currency is kept within certain fluctuation margins of at least +/- 1% around a fixed or de facto central exchange rate. It also includes the countries that participate in the exchange rate mechanism (ERM) of the European monetary system (ERM II). The degree of discretion of monetary policy depends on the width of the band.

Moving exchange rates

In this case, the currency is subject to small periodic adjustments, at a fixed rate or in response to changes in certain quantitative indicators. The exchange rate fluctuation rate may be set with an eye to generating inflation-adjusted currency value changes (“look-ahead”) or may be set at a pre-announced rate less than projected inflation differentials (“look-ahead”). To maintain this flexible exchange rate, monetary policy restrictions are imposed just like what happens in a fixed exchange rate system.

Exchange rates within fluctuation bands

The currency is maintained within certain fluctuation margins of at least +/- 1% around a central exchange rate adjusted periodically to a fixed rate or in response to changes in certain quantitative indicators. The degree of flexibility of the exchange rate depends on the width of the band; symmetric bands around a sliding central rate or gradually widening bands with an asymmetric fluctuation band of upper and lower bands can be adopted (in the latter case, there is no pre-announced central exchange rate). In order to keep the exchange rate within the band, there are limitations on monetary policy, and in turn its degree of independence depends on the width of the band.

Managed floating without a pre-announced path of the exchange rate

The monetary authority actively intervenes in the exchange market to determine the exchange rate without committing itself to a pre-announced trajectory. The indicators used to regulate this exchange rate are, in general, of a discretionary nature –they include, for example, the balance of payments balance, international reserves and the evolution of the parallel market- and the adjustments may not be automatic.

Independent Floating

In this type of regime the exchange rate is determined by the market through the game of supply and demand. The intervention is only intended to moderate the rate of change and avoid excessive fluctuations in the exchange rate, but not to establish its level. In principle, monetary policy in these regimes is independent of exchange rate policy.

Exchange Policy Framework

Using the exchange rate as an anchor

The exchange authority is willing to buy and sell currencies at certain prices to maintain the value of the currency at the established level. These regimes include exchange rate regimes where there is no legal tender, currency boards, fixed exchange rates with and without bands, and moving band rates with and without bands, where the fluctuation rate it is prospective.

Use of a monetary aggregate as an anchor

The monetary authority uses its instruments to achieve the target growth rate for a monetary aggregate and the target monetary aggregate becomes the nominal anchor or intermediate objective of monetary policy.

Framework based on the adoption of direct inflation targets

This framework requires the public announcement of medium-term numerical targets for inflation and the institutional commitment of the monetary authority to achieve those targets. They may also include greater communication with the public and the market about the plans and objectives of the authorities in charge of monetary policy and greater responsibility of the central bank for the achievement of its inflation targets. The inflation forecast acts (implicitly or explicitly) as an intermediate objective of monetary policy,

Other frameworks

Corresponds to those countries that have not established a nominal anchor and that follow the evolution of a set of various indicators in the management of their monetary policy. Countries for which exact information is not available are also included.