Q. Why do you think Central Banks might prefer a managed exchange rate system over a fixed or a floating exchange rate?
A. Managed exchange rate systems permit the government to place some influence on an exchange rate that would otherwise be freely floating. Managed means the exchange rate system has attributes of both systems. On one hand allowing one’s currency to be dictated in its entirety by a foreign nation would be undesirable since exogenous shocks from the pegged country would affect your currency.
There would be little control of the Central Bank to change expectations or impact the economy through a change in the exchange rate (thus impact interest rates through supply and demand for domestic currency) as the entire exchange system would be dependent on the foreign nation’s policies.
The central bank will also be in a position to utilize monetary policy to its advantage, or essentially, the changes in monetary policy will have their desired effect on a market where the exchange is not fixed.
Canada uses a managed exchange rate. they do not peg to the USD, and in fact permit the exchange rate to float so long as it remains with a certain target (which varies). If the CB doesn’t like how much the dollar declines they can put in place measures to slow a depreciation or appreciation. However, the central banks power to change the exchange rate trend through the markets is usually limited as their influence cannot match the overall buying power of the global market.
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