What defines a floating exchange rate?

A floating exchange rate is defined as one that is determined by supply and demand in the market. This means that the value of a currency can fluctuate freely, based on various economic factors such as trade balances, interest rates, inflation, and overall economic stability. In a floating exchange rate system, the central bank does not intervene to stabilize or control the currency value, allowing the market forces to dictate the exchange rate.

In this context, currencies can appreciate or depreciate depending on how much demand there is for one currency in relation to another. This flexibility can serve as an automatic stabilizer in the economy, as currency values can adjust to changes in economic conditions without requiring government intervention.

The other choices do not accurately describe a floating exchange rate. A floating exchange rate is not set by government policy or fixed against a commodity, which would instead indicate a managed or peg system. Additionally, a floating exchange rate does not remain unchanged over time; it is characterized by its variability, responding dynamically to market conditions.