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Define what 'dirty float' and its varieties are and if they are likely to achieve theirs objectives.

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Dirty Float AIM Define what 'dirty float' and its varieties are and if they are likely to achieve theirs objectives. Background Shortly after the Bretton Woods system collapsed in 1973, countries were free to use expansionary monetary and fiscal policies to raise output and took advantage of the benefits of flexible rates. But in the 1980s, many countries including U.S. started to suffer from very large exchange rate swings and the dissatisfaction with flexible exchange rate regimes was generated. During this time, the major developed countries tried to manage the exchange rate to some degree by having central banks intervene in the foreign exchange markets. This was not a move to an actual fixed exchange rate regime, but is often referred to as a "managed float." Main Argument Managed float (Dirty Float) Market forces set rates unless excess volatility occurs, then, central bank determines rate by buying or selling currency. Managed float is not really a single system, but describes a continuum of systems. Under a managed float exchange rate regime, market forces are the principal factors influencing the exchange rate, but the government may intervene by buying or selling its own currency in the market. This is sometimes called a dirty float because under this exchange rate system, though it is technically a free float, the government does participate in the trading of currency. ...read more.


2) Australia2 from July 1986 to September 1991, when the Reserve Bank of Australia eased the strengthening of the Australian Dollar. Indeed, they are good example but we will focus on one more extended example. The following diagram shows us in 3 steps the situation of the Euro during 1999 Source: www.worldgameofeconomics.com/EuroCurrencyIntervention.htm A) The Euro was introduced at $1.17 in January of 1999. B) Euro value declined to $0.85 in September 1999, mainly because Europeans investor required dollar to invest in US market. C) Due to this dramatically fell of the Euro, the European Central Bank, the Federal Reserve of the United State, the Bank of England, the Bank of Japan and the Bank of Canada bought Euros for approximately 2 billions of their dollar reserves. The justifications for this action were 1) This loss of value in the euro was affecting the new monetary union, 2) high oil price and euro devaluation would have brought inflation to inadmissible rate, 3) an ample gap between dollar and euro exchange would have encouraged protectionist action from United State in order to reduce the trade deficit; and 4) profit of American companies in Europe would have been affected. Objectives achieved or not? This action brought the Euro at $0.887, but does "leaning against the wind" archive its objectives? This question has been argued by many expect without coming up with any clear answer. ...read more.


Thus, we could infer that actions taken by central banks would be effective at first, but there is still uncertainty about the long-term effect of the moves. Factors such as "inflation fears of foreign countries" which is not easily predictable and controllable would affect the exchange rate and force the government watch the exchange markets constantly if they want to intervene the market. Conclusions 1. The intervention succeeds in the short term, like keeping down the inflation rate, reducing the real interest rate and stimulating the economic growth but it may not be controlled in the long- term because it might overdue and become a barrier of economic developing. 2. If the money supply is injected for a long time it may ignite inflationary pressures in the future. 3. Oppositions from other countries are likely to occur because this intervention would weaken their competitiveness. 4. To boost the economy, intervention in the exchange market is not the only way. Many experts say that a long-term monetary decision is more likely to achieve its objective. Besides, if the consumer confidence or the domestic demand do not increase, it is difficult to see the economy recovering. Summary In this report, the dirty float and its three different variants have been showed with the evidences and the objective achievements. Also, it can be seen how the central bank intervenes in the exchange rate by selling and buying currencies to keep their domestic currency at a rational level. ...read more.

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