Floating exchange rate system generally refers to free floating exchange rate system, as opposed to fixed exchange rate system. It means that a country does not stipulate the exchange rate fluctuation range between its own currency and foreign currencies, nor does it undertake the obligation to maintain the exchange rate fluctuation limit, but allows the exchange rate to float freely with the change of supply and demand in the foreign exchange market. Under this system, foreign exchange has completely become a special commodity in the international financial market, and the exchange rate has become the price for buying and selling this commodity.
Facing the impact of international capital flow on domestic economy, different exchange rate systems show different behaviors. Generally speaking, the choice of floating exchange rate is mainly determined by market forces. Choosing a fixed exchange rate requires the government to control the transnational flow of capital.
The "ternary paradox" theory holds that the three goals of monetary policy independence, exchange rate stability and free capital flow cannot be achieved at the same time, but only two goals can be achieved at the same time. In fact, countries can only choose two goals that are beneficial to them.
At present, the fixed exchange rate system and floating exchange rate system are still inconclusive.
The advantages of floating exchange rate system are: (1) floating exchange rate system can ensure the independence of monetary policy; (2) Floating exchange rate helps to alleviate external shocks; (3) There is less intervention, and the exchange rate will be determined by the market, which is more transparent; (4) There is no need to maintain huge foreign exchange reserves. However, people also have some concerns about the floating exchange rate: (1) Under the floating exchange rate system, the exchange rate often fluctuates too much, which may be unfavorable to trade and investment; (2) As the exchange rate fluctuates freely, people may speculate; (3) The floating exchange rate system puts forward higher requirements for a country's macroeconomic management ability and the development of financial markets. In fact, not every country can meet these requirements.
The advantages of fixed exchange rate system are: (1) the uncertainty of exchange rate fluctuation will be reduced; (2) Exchange rate can be regarded as a noun, which promotes the stability of price level and inflation expectation. However, the fixed exchange rate system also has some shortcomings: (1) it is easy to overestimate the local currency, weaken the competitiveness of local export commodities, and cause unsustainable long-term current account imbalance; (2) At the same time, rigid exchange rate arrangements may be regarded as implicit exchange rate guarantees, thus encouraging short-term capital inflows and unsecured foreign loans, and damaging the health of the local financial system. Under the fixed exchange rate system, a country either sacrifices the independence of its monetary policy or restricts the free flow of capital. Otherwise, it will easily lead to monetary and financial crises, such as European exchange rate mechanism crisis 1992 ~ 1993, Mexican peso crisis 1994, Asian financial crisis 1997 and Russian rouble crisis 1998. These countries in crisis have adopted a fixed exchange rate system, but at the same time, the degree is different.
To find a balance between the floating exchange rate system and the fixed exchange rate system, a better choice is the managed d F L o a T I ng exchange rate system. There are three tools to implement this exchange rate system, one is monetary policy tool; Second, the central bank's hedging intervention in the foreign exchange market; Third, a certain degree of capital control. This system can not only maintain the independence of monetary policy, but also make the exchange rate flexible to cope with internal and external shocks. At the same time, the capital account can be partially liberalized selectively, so that the capital flow can be controlled. At present, China implements a managed floating exchange rate system.