Floating Exchange Rate - Essay Example

Since, it is largely dependent on the working of supply and demand, it is said to be self-correcting. The value of the currency will depend on the factors that affect the supply and demand, similar to a simple commodity. If the demand for the currency is high, its value (which is reflective of its a price) will increase. On the other hand, a low demand for the currency in the world market, perhaps brought by a decline in the demand for the domestic products, will cause a depreciation of the currency.

Examining the supply side, an increase in the supply of the currency will cause its depreciation while a decline in supply will work the other way. The terms "appreciation" and "depreciation" are used to mean increase in value and decrease in value respectively. However, these terms are only used in the floating exchange rate regime as in the fixed exchange rate; they use the terms "evaluation" and "devaluation". We say that it is "largely", but not "entirely" dependent on the workings of the private market through the supply and demand because it is not entirely free from government intervention.

"In a floating regime, the central bank may also intervene when it is necessary to ensure stability and to avoid inflation", although this is much less often than in a fixed exchange rate regime (Investopedia).One way for the central bank to intervene in a floating exchange rate regime is through "buying and selling of its own currency reserves in the foreign exchange market