What characterizes a floating exchange rate?

A floating exchange rate is characterized by a system where the value of a currency is determined by the forces of supply and demand in the foreign exchange market. This means that the exchange rate fluctuates freely and can change at any moment based on changes in market conditions, such as variations in interest rates, inflation rates, and overall economic performance.

In this system, there is no government intervention to maintain a specific exchange rate value, which contrasts with fixed or stable exchange rate systems, where a government or central bank establishes a specific value and may adjust it periodically. The floating rate reflects the real-time conditions of the economy and the relative strength of different currencies against one another.

This flexibility allows currencies to adjust to economic shocks and other long-term changes in economic fundamentals without the need for government action, making it a dynamic approach to currency valuation.