A floating exchange rate prices a nation's currency against
other currencies according to supply and demand in the foreign
exchange market. Providing policymakers with a critical tool for
protecting their economies, this mechanism is used by most
developed markets as well as some of the larger emerging markets.
The economic rationale for a floating exchange rate is that it
shields an economy from the shocks that can occur under a fixed
rate system when the market forces a central bank to drop or
adjust its currency peg. If a central bank creates a fixed
value for its currency, it must constantly buy and sell that
currency to maintain its value at the desired level.
Central banks in this situation have a difficult time using
monetary policy to spur economic growth or target inflation or
interbank interest rates. Countries with floating exchange rates
have many more options for fighting economic problems and growing
on paths of their own choosing.
Despite their advantages, floating exchange rate systems draw
criticism when changes in currency valuation hurt industries. In
2010 the Turkish government
was criticized for its floating exchange rate
, which had caused the lira (
) to appreciate against developed currencies. Even though that
trend has continued, the lira continues to float freely in the
foreign exchange market.
The biggest recent news in the world of exchange rates is
Myanmar's (formerly Burma)
announcement that it will float the kyat
) as part of its push toward economic liberalization. The
Southeast Asian nation currently breaking out from decades of
military junta rule wants to
encourage the entrance of foreign corporations
like Coca-Cola (
) and PepsiCo (
). Myanmar's announcement may indicate some emerging market
economies believe a floating exchange rate is key to showing the
world that freer economic systems are about to develop.