Floating vs Pegged

Clean float refers to a currency exchange rate based solely on market supply and demand. As opposed to the pegged exchange rate, a clean float means a pure exchange rate wherein government intervention in determining the exchange value is non-existent. 

To better understand the clean float system, let’s look at the two exchange rate regimes more closely. 

The exchange rate is the monetary rate at which you can exchange one currency for the other. Broadly, there are two exchange rate systems: fixed (pegged) and floating (flexible). 

The former exists when a country sets the value of its national currency to the value of a more influential currency, commodity or even a basket of other currencies.  

Sometimes, the pegging is influenced by the country’s biggest trading partner. For example, the Riyal, the currency of Saudi Arabia, has been pegged to the US dollar at the rate of 3.75 since 1986.

Yet the floating or flexible exchange rate system is adopted by a higher number of global economies. Touted to be a ‘self-correcting’ exchange rate system, under the floating regime, the value of a currency is determined by the open market. 

Under the clean float regime, if a country’s growth prospects are upbeat, demand for its currency should pick up, causing an increase in its exchange rate value. Similarly, if a country’s economic outlooks looks bleak, its currency should dip in value, due to underwhelming demand in the market.

Is a clean float realistic?

An exchange rate is detrimental to a country’s economic growth and shapes key indicators such as inflation. If the exchange rate is left to the free will of the market, its value can become quite volatile.

Driven by macroeconomic events such as natural disasters, geopolitical tensions and economic cycles, markets can exert uncertainties in a clean float monetary system. This would, in turn, affect the country’s ability to pay off its debts, adversely impact its trade and boost inflation.

A healthy level of government intervention and control over monetary policy helps to stabilise markets and reduce the impact of market uncertainties. 

According to the International Monetary Fund, as of 2014, 42% of countries have adopted a managed float. Under this system, the exchange rate fluctuates every day depending on global market forces. However, the central bank has the right to intervene and influence the currency rate through its monetary policies.