A dirty float is the manipulation of a floating currency exchange to protect it from extreme market fluctuations. Such intervention means that the exchange rate is not truly free-floating, as the government can step in at any time to affect the rate. This is also known as a managed float, reflecting the fact that the government takes an active role in managing currency prices if intervention appears necessary. Such activities may be frowned upon by traders and other governments, which may have contributed to the somewhat derogatory slang term.
A number of factors can affect a nation’s currency exchange rate, including foreign trade, debt, and political events. Investors may also play a role, as heavy investment activity may trigger responses in the currency exchange rate. This can become particularly acute with currency speculation, where bubbles and similar events can destabilize a country’s currency. Investors may take advantage of such events to bet on fluctuations in the rate with the goal of profiting, as they can generate earnings whether rates rise or fall.
Central banks can use a number of tactics to keep the exchange rate within a target range. They may buy up currency to reduce available supplies if they have concerns about inflation, and can also release more money in the event of deflation. These activities may involve varying levels of intervention. Some governments may direct their central banks to take a hands-off policy with most fluctuations, only intervening when a dirty float is clearly necessary to prevent a crash.
Investors expecting a true floating exchange rate may observe abnormalities with a dirty float. Instead of allowing the currency’s value to move freely up and down in response to market forces, the central bank can manipulate it. A downward slide in values, for example, might be counteracted to stabilize the price or push it back up. Radical inflation could also be countered by the central bank. In both cases, free market forces are no longer the sole influence on currency values.
When nations use a dirty float, information about the central bank’s activities can be available from a variety of sources. This includes the financial media, which may speculate about activities occurring behind the scenes, as well as central bank announcements. A central bank could inform the population, for example, that it is retaining currency to address concerns about inflation. In addition to controlling the value of currency within the country, this would also have the net effect of pushing exchange rates and creating a dirty float.