Managed Currency: Meaning, How it Works, Benefits

What Is a Managed Currency?

A managed currency is influenced by a central bank, which can increase, decrease, or maintain its value, sometimes linked to another currency.

Key Takeaways

• A managed currency is influenced by a nation’s government or central bank, especially in foreign exchange markets.
• Central banks manage currency through issuing new currency, setting interest rates, and managing foreign currency reserves.
• Monetary authorities also manage currencies to weaken or strengthen the exchange rate if the market price changes rapidly.
• A completely unmanaged currency is a "free-float," but very few such currencies exist.

Understanding Managed Currencies

Currency is a liability and demand instrument of a financial institution or government that circulates as a substitute for money and is the legal tender in a country. A central bank or monetary authority manages a currency, with control over production, distribution, price stability, and economic growth.

A central bank may also intervene in foreign currency exchange markets to manage a currency’s exchange rate. All currencies are managed in this sense, as the currency manager chooses to either float the currency or actively intervene. The degree of intervention determines whether a currency is considered managed at a given time.

This degree of active management determines whether the currency has a fixed or floating exchange rate. Most currencies today float in the market, but central banks intervene to support or weaken a currency if its market price deviates too much. In extreme cases, managed currencies may have a fixed or pegged exchange rate maintained through continuous management.

How a Managed Currency Works

Central banks manage a nation’s currency through monetary policies, which fall into four general categories:

1. Issuing currency and setting interest rates to control growth, employment, consumer spending, and inflation.
2. Regulating member banks through capital or reserve requirements and providing loans and services.
3. Serving as an emergency lender to distressed commercial banks and even the government.
4. Buying and selling securities, including other currencies, in the open market.

Other techniques to manipulate currency values and exchange rates may be used, such as direct controls. Central banks intervene via monetary policy to influence domestic price inflation rates, GDP, and unemployment rates, affecting their value in foreign exchange.

These actions alter the supply available, raising or lowering the market value of currencies in terms of other currencies or real goods and services. Managing currency value and exchange rates is a primary responsibility of monetary authorities in domestic and foreign markets.

Types of Currency Management

Most currencies participate in a floating exchange system, where prices move based on market demand. The forex market is the largest financial market globally, with currencies exchanged at spot prices or through options forward delivery contracts.

Currency price changes can also happen due to domestic money supply and demand interacting with foreign exchange demand, known as a clean float or pure exchange. However, most major world currencies are managed to some extent. Managed currencies include the U.S. dollar, the European Union euro, the British pound, and the Japanese yen, with varying degrees of central bank intervention.

In a fixed exchange system, the rate is pegged to a commodity, another currency, or a basket of currencies. China shifted from a fixed system to a managed floating currency system, allowing its value to float within a selected range.

Why Use Managed Currency?

Floating currency exchange can experience volatility and uncertainty due to external forces like commodity prices. Governments intervene to control their monetary policies, stabilize markets, and limit uncertainty.

A country may control its currency by allowing it to fluctuate within set bounds. If the price moves outside these limits, the central bank may purchase or sell its own or other currencies.

In some cases, a government’s central bank may intervene in a foreign power’s currency. For example, the U.S. government bought Mexican pesos in 1995 to boost the currency and prevent an economic crisis when the Mexican peso rapidly lost value.