Exchange rate regimes

Introduction

The term exchange rate regime refers to the general operational principles applied in the forex market of a country. The regime usually manages the activities and ways the country administers its own local currency with respect to other world countries. There are numerous form of exchange rate requires though four are the most commonly used;

Flexible exchange rate requires

This is the most common exchange rate regime currently being used by most countries in the world. In this type of regime the forces of demand around supply are left to determine the equilibrium exchange rate without any interference from the central bank of a country. As a result of the independent movement of prices, the main advantage of this regime is that it helps in eliminating problems of balance of payments (BOP) especially deficits. However, due to the volatile nature of the market, it makes it practically impossible for business planning.

Fixed exchange rate regime

In this kind of regime, the prices of foreign currencies visa vice the local currency are usually determined by the central bank of Kenya of a country, taking into consideration other micro-economic variables in the country. As a result of the control from the central bank, the problems of volatility associated with the floating exchange rate require are eliminated. However, since the exchange rates are exogenously determined, the exchange rate can either be set above or below the equilibrium exchange rate. As a result there may be a deficit or a surplus of foreign currency thus bringing about problems and balance of payments.

Managed float exchange rate regime

In this kind of regime, the best attributes out the first two regimes (fixed and floating). As a result, we have a high breed sort of regime whereby, the volatile nature of the market due to the practice of the floating exchange rate regime are eliminated by central bank intervention in the short run only because it would not be sustainable to control the prices in the long run. However, a major downside to this regime is the fact that it would be impossible to tell where the changes in demand for foreign currency are either temporary or permanent.

Foreign exchange controlled exchange rate regime

In this case, the government controls who buys or sell foreign currency and at what price. This regime is mostly in use in countries with chronic balance of payment problems. This is a common case in the less developed countries where dictatorship regime most often set the exchange rate below the equilibrium exchange rate level. This usually represents a deficit in the demand for foreign currency that can not be sustained over time by the Central Bank. On the other hand, it would be a common case that most of the demand and supply of foreign exchange rotates within and around the government structures thus denying genuine businesses and investors opportunities to transact their projects. The excess deficit in foreign currency represents a deficit in the balance of payments on top of the fact that this would generally not be good for importers considering that majority of the raw materials in use in these countries are imported. This would most probably make the whole production process expensive thus making prices of goods to be relatively high.