Two currencies can have identical-looking rate tables and behave in completely different ways, because the number in one is produced by a market and the number in the other is produced by a decision. That difference is the exchange rate regime, and it is worth knowing which one you are dealing with.
The three families
Free float. The rate is whatever the market produces. The central bank sets interest rates for domestic reasons and lets the currency go where it goes. The dollar, the euro, sterling and the yen all sit here. It does not mean the authorities never comment or never intervene — it means there is no target level.
Hard peg. The rate is fixed to another currency and defended mechanically. A currency board is the strictest form: domestic money is issued only against foreign reserves, so the peg is built into the balance sheet rather than defended by discretion. Hong Kong operates a linked exchange rate system that keeps the Hong Kong dollar within 7.75 to 7.85 per US dollar, with the monetary authority obliged to trade at the edges.
Managed float, and everything between. The largest and messiest category. A central rate exists, sometimes published and sometimes not, and the central bank leans against moves away from it. Denmark is the formal European example: the krone participates in ERM II with a central rate against the euro and a narrow band of ±2.25%, far tighter than the ±15% standard band, and in practice it trades very close to the centre.
The IMF classifies regimes by what countries actually do rather than what they announce, precisely because the gap between the two is common.
What each one feels like from the outside
| Regime | Day-to-day movement | What a big move means |
|---|---|---|
| Free float | Constant, small, both directions | Usually news; occasionally a repricing |
| Managed float | Small and one-directional for long stretches | A change in policy, not in the market |
| Hard peg | Almost none | Either nothing, or a crisis |
The last row is the one that catches people out. A pegged currency looks like the safest thing on the table until the peg goes, at which point the entire adjustment that a floating currency would have spread over two years happens in an afternoon. Switzerland's franc is the illustration everyone reaches for: a ceiling held for over three years, then removed on 15 January 2015, and a move in minutes that no floating currency would produce.
Why a country picks one
Pegs buy predictability. For a small, open economy with most of its trade in one partner's currency, a stable rate against that partner removes a large source of uncertainty from every contract, and it imports the anchor of a credible central bank's inflation record.
The price is autonomy. Under a hard peg the domestic interest rate is effectively set abroad. If the anchor country needs high rates and you need low ones, you get high ones. That trade-off — a fixed rate, free capital movement, and an independent monetary policy, of which you may have any two — is the oldest constraint in the subject.
Floating gives the policy back and charges you volatility for it. A floating currency also absorbs shocks: when exports fall, the currency weakens and does part of the adjusting that would otherwise have to come out of wages and employment.
What it changes when you change money
Three practical consequences.
How much a range tells you. For a floating pair, the past year's high and low is a genuine measure of your exposure. For a tightly managed one, the range describes a policy band and tells you almost nothing about what happens if the policy changes.
How wide the spread is. Pegged and thinly traded currencies carry wider retail spreads, because the counter holding them cannot offload them easily. This is separate from stability and often surprises people: a currency can be rock steady and still expensive to buy.
Whether stability is the same as safety. It is not. A stable rate under capital controls, with a parallel market operating alongside the official one, means the published number is not the number you would actually get. Where you see an official rate and a widely quoted unofficial one for the same currency, the regime is the reason.
For a floating pair, the useful check before a large conversion is not a forecast but the shape of the last year — which is what the charts are for. For a managed one, the useful check is what the policy is, because that is the whole story.
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Frequently asked questions
How an exchange rate is actually set, what a spread costs on a real transaction, what happens when your income and your debt are in different currencies, and what to check before paying or being paid abroad. They explain mechanisms rather than forecast rates, and each one carries the date it was last revised at the top.
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