Why Did Russia Decide to Let the Ruble Float?

For much of the post-Soviet era, Russia pegged its currency, the ruble, to the US dollar (USD). However, this decision faced criticism, as it often led to the ruble being perceived inaccurately. Russia now allows its currency to float, which means it is determined by the market forces of supply and demand. This change was announced by the chief of the Russian Central Bank, marking a significant shift in the country's monetary policy.

The change in the ruble's exchange rate has been a long-standing debate in economic policy circles. Prior to this decision, most countries had adopted a limited floating exchange rate system, where the currency's value fluctuates within a predetermined range. This system provides some stability and flexibility to manage economic challenges.

Understanding Currency Floating

When a country allows its currency to float, it gives up direct control over its exchange rate. This means that the value of the currency is determined by the market forces of supply and demand. As such, the monetary authorities can concentrate on managing the country's monetary policy without worrying about how changes in interest rates affect the currency value.

The Benefits of Floating Currency

One significant advantage of a floating currency is that it allows monetary authorities to focus on internal economic policies without the immediate pressure of managing the currency's value. High interest rates typically attract foreign investment, increasing the demand for the country's currency. Countries like Australia, with strong economic fundamentals, benefit from fully floating currencies, as they are less affected by external shocks.

The Risks of Floating Currency

However, a floating currency also poses risks. In times of market volatility, a full exchange rate can lead to a rapid decline in the currency's value, as seen during the 1997 Asian Financial Crisis. During this period, several Asian currencies experienced runs, causing significant economic turmoil. For countries heavily dependent on international trade, a volatile currency can create uncertainty and disrupt economic activities.

Alternative Exchange Rate Strategies

To mitigate these risks, countries with weaker economic fundamentals or those heavily reliant on external trade often opt for managed float systems or fixed exchange rates. Managed float systems maintain some degree of control over the currency's value while allowing it to fluctuate within a specific range. Fixed exchange rates, on the other hand, maintain a stable value by pegging it to another currency, typically a major global currency like the US dollar.

A Deeper Look at Russia's Motivations

Russia's motivation to allow the ruble to float lies in its desire to maintain more control over its economic policies and avoid the vulnerabilities associated with a fixed exchange rate. By floating the ruble, Russia can manage its economic challenges more flexibly and without the pressure of maintaining an artificial exchange rate.

Conclusion

Deciding whether to allow a currency to float or to maintain a fixed or managed exchange rate is a complex process. Each strategy has its pros and cons, and the choice depends on the country's economic situation and objectives. Russia's decision to allow the ruble to float is a significant move that aligns with its broader economic goals and offers greater policy flexibility in the face of global economic challenges.