Floating exchange rate

A floating exchange rate is a rate of currency exchange which changes, depending on conditions present in the market. In an ideal world, the foreign exchange market should be steady. However, this is not usually the case, and changes in worldwide trade bring about fluctuations in the value of currencies. This means that market changes, such as adjustments in supply and demand of a particular currency, can bring about effects that touch individuals on the most basic levels. For example, a certain amount of a weaker currency may become equal to a lessened amount of money in the stronger currency, therefore negatively affecting the spending power of the holders of the first currency.

Several other factors may bring about exchange rate fluctuations. An oversupply of a currency, for instance, may have the effect of devaluing a currency. While governments often try to let market forces work themselves out naturally, certain situations may require a some kind of intervention. In case devaluation occurs as a result of oversupply, a government may put printing of currency on hold or even resort to more drastic measures, such as currency recall.

The opposite of a floating exchange rate is a fixed exchange rate. In more concrete terms, if a currency has a fixed exchange rate, it means that the rate remains stable even in the midst of fluctuations in the foreign exchange market. Changes may occur, but these may come about as a result of certain specific conditions. Currencies with fixed exchange rates are pegged to a currency which is considered much stronger internationally, such as the U.S. dollar or the euro.