Floating or flexible exchange rate is determined by the market forces of demand and supply. In a completely floating exchange rate system, the Central Bank do not interfere in the foreign exchange market. Demand for a foreign currency increases in cases of increased imports or international travels or higher investments in securities of other countries. This increase the exchange rate and depreciates the domestic currency. Depreciation has a positive price impact on exports which increases and negative impact on imports which decreases.
If a Central Bank of a country buys and sells foreign currencies to moderate exchange rate movements under a flexible exchange rate system then this informal arrangement is called.
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Managed floating exchange rate system
Here the rate is mostly left to the market. But the central bank buys and sells foreign currencies to stop sharp swings. It is a mix of the flexible system (the float part) and the fixed system (the managed part). It is also called dirty floating.
Option (1) Floating exchange rate system — Incorrect. Here the rate is set by demand and supply alone. As the passage says, the central bank does not step into the market.
Option (2) Fixed exchange rate system — Incorrect. Here the government fixes the rate at a chosen level and keeps it there. Such a rate does not move with the market at all.
Option (3) Managed floating exchange rate system — Correct. The central bank steps in only to moderate exchange rate movements.
Option (4) Gold standard — Incorrect. Under the gold standard, each currency was tied to a fixed amount of gold. That fixed the rates between currencies. It was an old fixed-rate system.
Note: A same/similar question was asked in CUET (UG) in the papers below.
| 2026 | 2025 | 2024 | 2023 | 2022 |
| 13-05 S1* | 21-05 S1* 22-05 S2* 29-05 S2* | – | 29-05 S1* 12-06 S2 | – |
* A similar question.
NCERT (2026-27): “Flexible Exchange Rate …In a completely flexible system, the Central banks do not intervene in the foreign exchange market.… Fixed Exchange Rates In this exchange rate system, the Government fixes the exchange rate at a particular level.… 6.2.4 Managed Floating Without any formal international agreement, the world has moved on to what can be best described as a managed floating exchange rate system. It is a mixture of a flexible exchange rate system (the float part) and a fixed rate system (the managed part). Under this system, also called dirty floating, central banks intervene to buy and sell foreign currencies in an attempt to moderate exchange rate movements whenever they feel that such actions are appropriate. Official reserve transactions are, therefore, not equal to zero.” |