The Floating Currency Exchange Rate System 213 Jamaica Agreement that established the rules for the floating system was both worked out and accepted by IMF members after the fact, in 1976. It allows for flexible exchange rates among IMF members, while condoning central bank operations in the money markets to smooth out volatile periods. It also demonetized gold, which was abandoned as a reserve currency. Such is our trust in gold’s value, though, that many nations still use it as a reserve asset, including the United States and the EU members. CURRENT CURRENCY ARRANGEMENTS The IMF now recognizes eight types of currency exchange arrangements, extended from an initial three. These eight strategies describe the way countries position their currencies in relationship to other currencies, and they vary in their degree of flexibility.11 • Exchange arrangement with no separate legal tender: One country adopts the currency of another, or a group of countries adopt a common currency. Examples of the first strategy are the adoption of the U.S. dollar in El Salvador, Panama, Zimbabwe, and Ecuador, and Kosovo and Montenegro’s adoption of the euro (both countries wish to join the European Union). An example of the second, a common currency, is the euro, the shared currency in 18 EU member-countries. • Currency board arrangement: A currency board arrangement commits the country’s government to holding foreign reserves of a specific currency in an amount equal to its domestic currency supply and exchange the two at a fixed rate. Hong Kong, St. Kitts, Nevis, Grenada, Dominica, and Djibouti use the U.S. dollar. Bulgaria, Lithuania, and Bosnia Herzegovina use the euro. • Conventional fixed-peg arrangement: A fixed-peg or fixed-rate relationship allows a currency’s exchange rates with one or a basket of currencies to fluctuate around a fixed rate within a narrow band of less than 1 percent. Saudi Arabia, Jordan, Oman, Turkmenistan, the United Arab Emirates, and the Bahamas are among the countries pegged to the U.S. dollar. Denmark, Latvia, Benin, Burkina Faso, Côte d’Ivoire, and the Republic of Congo are among the countries pegged to the euro. • Stabilized arrangement: Pegged exchange rate within a horizontal band: In a different peg arrangement, exchange rate fluctuations greater than 1 percent are allowed. Cambodia and Trinidad and Tobago have this arrangement with the U.S. dollar. Macedonia and Vietnam have this arrangement with the euro. • Crawling peg: In a crawling peg strategy, a currency is readjusted periodically at a fixed, preannounced rate or in response to changes in indicators. Nicaragua has this arrangement with the U.S. dollar. China has been relaxing its dollar peg since 2005, managing its currency against a basket of trading currencies. • Crawling band: A crawling band readjusts the country’s currency to maintain fluctuation margins around a central rate. In 2013, only Tonga listed this arrangement, linked to a basket of currencies, but in times of crisis, it may be found useful. This arrangement is known as a snake in the tunnel in the London foreign exchange markets. • Managed floating: In a managed float the currency fluctuates, while the country’s monetary authority actively intervenes on the exchange market without specifying or making public its goals and targets. Peru, Korea, Mexico, the Philippines, South Africa, Turkey, India, and Pakistan are among the many countries that follow this arrangement. • Free floating exchange rates: Free floating exchange rates rely on the market. Governments may intervene, but to moderate the rate of change rather than to establish the currency’s level. Countries following this approach are the Canada, the UK, the United States, Sweden, Japan, and the EU countries. Table 8.1 shows the changes in currency arrangements from 2009 through 2013, using the original three IMF groups. You can see the impact of the 2008 financial crisis. Countries moved initially toward floating and then toward soft pegs, a term used to describe the peg, crawling peg, stabilized, and crawling band, or other arrangements. Jamaica Agreement The 1976 IMF agreement establishing flexible exchange rates among IMF members
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