My country just started to “float” the currency to get money from IMF and WB, what are going to be the day to day results of this decision?
In: Economics
If a country “pegs” their currency they guarantee to keep the exchange rate with another currency (or bundle of currencies) within a certain narrow range.
This helps make trade and investment more predictable because everyone knows what the exchange rate will be in the future.
Imagine there’s a 1:1 exchange rate between the pound and the dollar. If I sign a deal saying that you’ll build me a yacht and when it’s done I’ll pay you $1 million. I know that will cost me £1 million.
If the currency “floats” that exchange rate can change. Maybe it’ll cost me £1.2 million. Maybe I’ll get lucky and it’ll only cost me £0.8 million.
There are downsides though. What if people don’t want pounds? They keep selling pounds and buying dollars. That will push the exchange rate down. If the UK government wants to maintain the exchange rate, they’re going to do something about that. Maybe increasing exports, maybe reducing imports, maybe encouraging investment, selling dollars or buying pounds (or even more drastically, impose controls on buying/selling the currency).
This can get very difficult and very expensive, and sometimes in the end it fails and the currency has to be floated or the exchange rate changed. The failure of an exchange rate policy can be very bad because it means a sudden change in the value of a currency (usually after lots of money spent and other economic costs).
Also other countries can sometimes dislike it when they think an exchange rate is set too high or low, as it can conflict with their own goals (eg. China is often accused of keeping its currency value low to “unfairly” benefit its export industries).
Floating the currency avoids these problem. It aims to let the market balance out the exchange rate, and quantities of imports, exports and investments.
What you’re going to see is a change in exchange rates – most likely in this situation your currency is going to lose value. That will make imports more expensive. So it’ll increase inflation. On the other hand it will make exports cheaper, which is good for exporters and could boost growth. Over the longer run things will hopefully find a(n ever changing) balance.
Exchange rates will definitely be more unpredictable, which is generally bad. However your government will no longer have to go to the trouble and expensive of maintaining the value of the currency, and ideally you’ll have less risk of a sudden sharp change in the value.
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