In the previous chapter, we reviewed arguments for and against various exchange rate regimes. We saw that in the special cases of clean floats or hard pegs, the authorities have no need to make day-to-day decisions about how the exchange rate should be managed. In these cases, all decisions concerning exchange rate management are effectively made at the time that the regime is adopted. It may indeed be optimal for a country to adopt a regime of one of these polar types, depending on its circumstances, and the previous chapter reviewed some of the considerations involved in determining whether it would be appropriate to do so. But as we saw at the end of the preceding chapter, for many countries, the conditions that would make such an exchange rate regime appropriate are not likely to be met. When such a regime is not adopted, the exchange rate will have to be managed in some fashion, whether through intervention in the foreign exchange market or by using monetary policy.

This chapter examines some basic principles of exchange rate management in such intermediate regimes. We will use as an organizing framework the assumption that a country maintains a band, basket, and crawl (BBC) exchange rate arrangement because, with a slight modification, all the managed exchange regime options available to an emerging economy can be thought of as variations on such an arrangement.