Zone of Rate Flexibility

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Definition: Zone of Rate Flexibility

Zone of Rate Flexibility refers to a flexible exchange-rate system in a monetary system that lets the exchange rate be determined by the market forces of supply and demand. The degree of flexibility depends on the type of exchange system adopted by the economy.


A crawling peg attempts to combine flexibility and stability of an exchange system for gradually altering the currency's par value. A crawling peg is similar to a fixed peg, the difference being that it can be adjusted based on a set of defined rules. It is very often used by countries battling high inflation or developing nations who peg to low inflation countries in attempt to avoid currency appreciation and inflation as well.


A managed float exchange rate is determined in the Forex market and is accompanied by an anchor such as a set inflation target. The main drawback of this system is that it does not place any hard constraints on the monetary and fiscal policies within the economy.


In a pure float exchange rate, public intervention is zero and the system is controlled totally market forces. Hence, it eliminates the need to have large forex reserves.

 

The above is a diagram representing Zone of Rate Flexibility


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