What Is Joint Float?
A joint float refers to an exchange rate arrangement where a group of countries collectively agree to maintain their respective currencies within narrow fluctuation bands against each other, while allowing their combined block of currencies to float more freely against external currencies. This system is a sophisticated form of managed float within the broader field of international finance. The primary aim of a joint float is to foster economic stability and facilitate trade among participating nations by reducing intra-group exchange rate volatility, even as the block as a whole responds to global foreign exchange market dynamics. A joint float typically involves coordinated intervention by the participating central banks to uphold the agreed-upon parities.
History and Origin
The concept of a joint float gained prominence in the early 1970s as a response to the collapse of the Bretton Woods system of fixed exchange rates. With the U.S. dollar no longer convertible to gold, and the Smithsonian Agreement's wider bands proving insufficient, European nations sought to protect their nascent economic integration from the turbulence of freely floating exchange rate regimes.6
A significant historical example of a joint float was the "snake in the tunnel" mechanism, created by the Basel Agreement on April 24, 1972, by governors of the European Economic Community (EEC) central banks.5 This arrangement aimed to limit the fluctuation margins between European currencies (the "snake") to ±2.25% around their bilateral parities, while the entire group was permitted to fluctuate more widely (the "tunnel") against the U.S. dollar. The "tunnel" aspect faded in 1973 when the U.S. dollar began to float freely, but the "snake" persisted, forming a core of stability among some European currencies. This initial joint float was a precursor to subsequent European monetary cooperation efforts, including the European Monetary System (EMS) and eventually the European Monetary Union (EMU) and the introduction of the euro.
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Key Takeaways
- A joint float is an exchange rate regime where a group of currencies maintains stable bilateral parities while collectively floating against external currencies.
- It aims to reduce exchange rate volatility among participating countries to promote regional trade and economic stability.
- The "snake in the tunnel" was a historical joint float mechanism among European nations in the 1970s.
- Maintaining a joint float requires significant coordination and intervention by the participating central banks.
- This arrangement represents a middle ground between rigidly fixed exchange rate systems and entirely free-floating regimes.
Interpreting the Joint Float
In a joint float arrangement, the stability of internal exchange rates is paramount. This stability reduces exchange rate risk for businesses trading within the bloc, fostering regional trade and investment. For example, if Germany and France are part of a joint float, their bilateral exchange rate would remain relatively stable, making it easier for German companies to import from or export to France without fear of sudden and large currency fluctuations eroding profits.
However, the combined block's external exchange rate would still be influenced by market forces, responding to overall balance of payments dynamics and global economic shifts. The success of a joint float hinges on the willingness and ability of member countries to coordinate their monetary policy and fiscal policies to support the agreed-upon parities, often requiring intervention in the foreign exchange market by the central bank of each participant.
Hypothetical Example
Imagine a hypothetical "Pacific Trade Bloc" (PTB) consisting of three nations: Nation A, Nation B, and Nation C. Historically, each nation had its own independent currency (Currency A, Currency B, Currency C) that floated freely against each other and the rest of the world. To boost intra-bloc trade and investment, the PTB central banks agree to establish a joint float.
They set central parity rates for Currency A, B, and C against each other, allowing for a narrow fluctuation band of, say, ±1%. Outside this band, the central banks are committed to intervening. Collectively, the PTB currencies as a block float against other major global currencies like the U.S. dollar or the Japanese yen.
If Currency A starts to appreciate significantly against Currency B, nearing the upper limit of the agreed band, the central banks of Nation A and/or Nation B would intervene. Nation A's central bank might sell Currency A and buy Currency B, while Nation B's central bank might sell Currency B and buy Currency A, to bring the rate back within the band. This coordinated action maintains the internal stability of the joint float, even as the value of the PTB block fluctuates against external currencies based on collective economic performance.
Practical Applications
While the "snake in the tunnel" was a specific historical arrangement, the principles of a joint float continue to be relevant in discussions of regional economic integration and managed exchange rate systems. Many countries, particularly emerging markets, adopt some form of managed floating, even if not explicitly a "joint float" of multiple currencies. According to the International Monetary Fund, as of 2013, a significant percentage of countries utilized a managed float regime.
Central banks in such regimes frequently intervene in the foreign exchange market to influence their currency's value, aiming to stabilize it or steer it towards specific economic goals, such as managing inflation or supporting export competitiveness. The experience of countries operating under managed float regimes, including those that were part of joint floats, provides valuable insights into the complexities of balancing domestic policy objectives with external exchange rate stability.
3## Limitations and Criticisms
Despite its benefits in fostering regional stability, a joint float faces significant limitations and criticisms. The primary challenge lies in maintaining internal consistency among participating economies. Member countries must align their monetary policy and fiscal policies to support the fixed bilateral parities. Divergent economic conditions, such as differences in inflation rates or economic growth, can put immense pressure on the system, making it difficult to maintain the agreed-upon bands.
For instance, if one country experiences higher inflation than its partners, its currency would naturally tend to depreciate, requiring persistent intervention to prop it up. Such interventions can deplete a nation's foreign exchange reserves or force it to adopt interest rate policies that may not be suitable for its domestic economic situation. The "snake in the tunnel" itself faced challenges, with several currencies leaving and rejoining due to speculative attacks and differing economic policies among members.
Moreover, the more rigid the internal bands, the less independent monetary policy each nation can pursue. This can be a significant drawback, particularly during economic crises, where the ability to adjust interest rates or allow the exchange rates to depreciate can be crucial for economic adjustment. T2he maintenance of a pegged or heavily managed exchange rate, even within a joint float, can be very costly and requires unwavering sound macroeconomic policies, especially for countries deeply integrated with international capital movements.
1## Joint Float vs. Managed Float
While a joint float is a specific type of managed float, it has distinct characteristics that differentiate it. A "managed float" generally refers to any exchange rate regime where a country's central bank intervenes in the foreign exchange market to influence its currency's value, without committing to a rigidly fixed rate. The intervention aims to smooth volatility, counteract undesirable trends, or achieve specific economic objectives like controlling inflation or boosting exports. A single country can operate a managed float independently.
In contrast, a joint float involves multiple countries that collectively agree to manage their currencies. The defining feature of a joint float is the commitment to maintain relatively stable bilateral exchange rates among themselves, creating a zone of internal currency stability. While this bloc then floats as a whole against outside currencies, the core agreement is about intra-group currency management. Therefore, a joint float requires a higher degree of policy coordination and collective intervention compared to a solitary managed float.
FAQs
What is the primary purpose of a joint float?
The primary purpose of a joint float is to stabilize exchange rates among a group of participating countries, typically to foster trade and economic integration within that group. This internal stability is maintained while the collective bloc of currencies floats against external currencies.
How does a joint float differ from a fixed exchange rate?
A fixed exchange rate ties a currency to another currency or commodity at a specific, unchangeable rate. In a joint float, while there are narrow bands for internal fluctuations, the entire bloc of currencies still allows for broader movements against currencies outside the agreement. It's a system of managed flexibility rather than absolute rigidity.
What was the "snake in the tunnel"?
The "snake in the tunnel" was a historical example of a joint float mechanism initiated in 1972 by European countries. It aimed to limit fluctuations among their currencies ("the snake") within narrow bands, while allowing this group to float more freely against the U.S. dollar ("the tunnel"). This arrangement was a precursor to the European Monetary System (EMS).
Why are joint floats challenging to maintain?
Joint floats are challenging to maintain because they require strong economic policy coordination among participating nations. Divergent economic conditions, such as differing inflation rates or growth trajectories, can strain the agreed-upon exchange rate bands, necessitating frequent and often costly interventions by central bank authorities.