How are appreciation and depreciation used in a managed exchange rate?

Appreciation: It refers to the increase in the value of a country's currency in terms of another currency in a floating exchange rate system.

Depreciation: It refers to the decrease in the value of a country's currency in terms of another currency in a floating exchange rate system.

Managed Exchange Rate (or Dirty Float): It's an exchange rate system where the value of a currency is determined by the forex market but is subject to government or central bank intervention to prevent excessive fluctuations.

Under a managed exchange rate system, central banks use foreign exchange reserves to buy or sell their own currency in order to influence its value. If a central bank wants to prevent its currency from falling too much (depreciating), it might sell its reserves of foreign currency and buy its own currency. This increases demand for its own currency and therefore its value appreciates.

On the other hand, if the central bank wants to stop its currency from rising too much (appreciating), it might buy foreign currency and sell its own. This increases the supply of its own currency, leading to a depreciation of its value.

Appreciation and depreciation are key tools used by central banks under a managed exchange rate system to maintain a stable economic environment. They can be used to control inflation, protect domestic industries, and maintain competitiveness in international trade.

China is a notable example of a country that uses a managed exchange rate system. The People's Bank of China has been known to intervene in the foreign exchange market to control the rate of the Yuan against the US Dollar and other currencies to maintain its export competitiveness.

The Bank of England intervened in the foreign exchange market during the Black Wednesday crisis in 1992, trying to prevent the British Pound from depreciating. However, it eventually had to abandon the fixed exchange rate system and let the Pound float freely.

To summarise, appreciation and depreciation are mechanisms through which central banks manage the value of their currency under a managed exchange rate system. By selling and buying their own currency against foreign currencies, they can influence its value to achieve economic objectives such as controlling inflation, protecting domestic industries, and maintaining competitiveness. However, these interventions come with trade-offs and risks, and their success often depends on the country's underlying economic fundamentals and the central bank's credibility.