A fixed or pegged currency is one where the currency’s value is matched to that of another. The asset may be a single currency, or it may be a basket. The fixed rate will be determined by central banks.
Fixed exchange rate mechanisms can be introduced for a number of reasons, offer a number of advantages or disadvantages for the economy of nation which utilizes them. A pegged currency can be very useful in combating inflation in an environment where the public has lost confidence in the nation’s economic policies, and prices keep rising uncontrollably as a result. The peso was pegged to the US dollar by Carlos Menem to stop rampant inflation in 90’s Argentine. It may be temporarily introduced to protect an economy from currency volatility that is caused by speculators or event shocks.
In response to the Asian Crisis of 1998, speculator attacks, Malaysia had to keep the ringgit pegged to the dollar for seven years.. Another reason for maintaining a fixed currency is to defend the profits of exporters in a nation against normal currency fluctuations which make predictions difficult. Hong Kong was one of the nations that maintained such a peg until 2008. Since then the currency floats in a band. A peg may be implemented to facilitate convergence between the financial systems of two nations where increased cooperation, or even ultimate merger is desired. This has been the case in Denmark, and various small Balkan nations which aspire to join the Euro eventually. Finally, the peg may be maintained for political reasons and this is the case with most Gulf Arab States.
The advantages of the fixed exchange rate systemborn of its clarity and simplicity. By pegging the currency, the central bank of the nation is declaring its intention to limit its expansion of the money supply by adhering to policies of the other, more credible central bank. It gives up its independence in setting policy rates and following its own currency policies in response to domestic needs, but in return gains the ability to rapidly suppress inflation expectations that are otherwise uncontrollable.
The problems with fixed exchange rate systems arise out of the inability of the system to adapt to changing conditions. For instance, a currency peg adopted time when the nation possessed ample forex reserves is unlikely to function well when the current account surplus evaporates and all that defends the rate is the intervention promise of the central bank. Market participants are unlikely to regard such a promise seriously, and this lack of credibility has the potential to create currency crises
Fixed exchange rate mechanisms can be introduced for a number of reasons, offer a number of advantages or disadvantages for the economy of nation which utilizes them. A pegged currency can be very useful in combating inflation in an environment where the public has lost confidence in the nation’s economic policies, and prices keep rising uncontrollably as a result. The peso was pegged to the US dollar by Carlos Menem to stop rampant inflation in 90’s Argentine. It may be temporarily introduced to protect an economy from currency volatility that is caused by speculators or event shocks.
In response to the Asian Crisis of 1998, speculator attacks, Malaysia had to keep the ringgit pegged to the dollar for seven years.. Another reason for maintaining a fixed currency is to defend the profits of exporters in a nation against normal currency fluctuations which make predictions difficult. Hong Kong was one of the nations that maintained such a peg until 2008. Since then the currency floats in a band. A peg may be implemented to facilitate convergence between the financial systems of two nations where increased cooperation, or even ultimate merger is desired. This has been the case in Denmark, and various small Balkan nations which aspire to join the Euro eventually. Finally, the peg may be maintained for political reasons and this is the case with most Gulf Arab States.
The advantages of the fixed exchange rate systemborn of its clarity and simplicity. By pegging the currency, the central bank of the nation is declaring its intention to limit its expansion of the money supply by adhering to policies of the other, more credible central bank. It gives up its independence in setting policy rates and following its own currency policies in response to domestic needs, but in return gains the ability to rapidly suppress inflation expectations that are otherwise uncontrollable.
The problems with fixed exchange rate systems arise out of the inability of the system to adapt to changing conditions. For instance, a currency peg adopted time when the nation possessed ample forex reserves is unlikely to function well when the current account surplus evaporates and all that defends the rate is the intervention promise of the central bank. Market participants are unlikely to regard such a promise seriously, and this lack of credibility has the potential to create currency crises
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