"A fixed exchange rate, often called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold."
Explanation of what currency pegging is, how it works, and the risks and benefits involved.
Currency Pegging: This involves setting a fixed exchange rate between one country's currency and another currency, which is usually the US dollar or the euro.
Fixed exchange rate system: A system where the exchange rate is fixed by the government, which means the currency is pegged to a foreign currency.
Floating exchange rate system: A system where the exchange rate is not fixed, and can fluctuate based on market demand and supply.
Money supply and demand: The amount of money in circulation and how it affects the exchange rate.
Forex Market: Where currencies are traded, including spot and futures markets.
Central Bank: The institution responsible for monetary policy, including currency pegging.
Exchange rate regime: The way in which a country manages its exchange rate, either by pegging it or allowing it to float freely.
Balance of payments: The accounting of all the financial transactions between a country and the rest of the world.
Currency crisis: When a country's currency experiences sharp and sudden depreciation, leading to economic instability.
Capital controls: Policies that restrict the flow of capital in and out of a country.
Monetary policy: Actions taken by a central bank to manage the money supply and inflation.
Inflation targeting: A monetary policy strategy that aims to keep inflation within a predetermined target range.
Interest rates: The cost of borrowing money, which can also affect currency values.
Financial globalization: The increasing interconnectedness of financial markets and institutions around the world.
International Monetary Fund (IMF): An organization that assists member countries with financial stability issues, including currency pegging.
Fixed exchange rate: This is a type of pegging that involves fixing a specific exchange rate between two currencies. The central bank of the country sets the exchange rate and uses its monetary policy tools to maintain the peg.
Crawling peg: This is a type of pegging that involves gradually adjusting the exchange rate of a currency. The central bank may use a pre-determined formula or make ad hoc adjustments to the fixed exchange rate to reflect changing economic conditions.
Dual exchange rate: In this system, there are two official exchange rates for a currency. One rate is used for official transactions (such as trade and government transactions), while the other is used for other transactions. This type of pegging is mainly used by countries with strict capital controls.
Adjustable peg: This is a type of pegging that allows for some flexibility in the exchange rate. The central bank may periodically adjust the exchange rate to reflect changing economic conditions. This type of pegging is often used by developing countries.
Basket peg: This type of pegging involves fixing the exchange rate of a currency to a basket of other currencies. The central bank monitors the exchange rates of the currencies in the basket and adjusts the exchange rate of the pegged currency as necessary to maintain the peg.
Managed float: This is a flexible exchange rate system in which the central bank intervenes in the foreign exchange market to influence the exchange rate of the currency. This system is often used by developed countries with relatively stable economies.
Free float: In this system, the exchange rate of a currency is determined by supply and demand in the foreign exchange market. The exchange rate is not fixed or controlled by the central bank.
Currency board: This is a type of fixed exchange rate system in which the central bank holds foreign currency reserves equal to the amount of domestic currency in circulation. The exchange rate is fixed and there is no flexibility in the system. This system is often used by small open economies.
"A fixed exchange rate is typically used to stabilize the exchange rate of a currency by directly fixing its value in a predetermined ratio to a different, more stable, or more internationally prevalent currency (or currencies) to which the currency is pegged."
"This makes trade and investments between the two currency areas easier and more predictable and is especially useful for small economies that borrow primarily in foreign currency and in which external trade forms a large part of their GDP."
"A fixed exchange rate system can also be used to control the behavior of a currency, such as by limiting rates of inflation."
"According to the Mundell–Fleming model, with perfect capital mobility, a fixed exchange rate prevents a government from using domestic monetary policy to achieve macroeconomic stability."
"To maintain a desired exchange rate, the central bank during a time of private sector net demand for the foreign currency, sells foreign currency from its reserves and buys back the domestic money."
"In the case of an incipient appreciation of the domestic money, the central bank buys back the foreign money and thus adds domestic money into the market, thereby maintaining market equilibrium at the intended fixed value of the exchange rate."
"The last large economy to use a fixed exchange rate system was the People's Republic of China, which, in July 2005, adopted a slightly more flexible exchange rate system, called a managed exchange rate."
"The European Exchange Rate Mechanism is also used on a temporary basis to establish a final conversion rate against the euro from the local currencies of countries joining the Eurozone."
"A currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold."
"This makes trade and investments between the two currency areas easier and more predictable."
"It is especially useful for small economies that borrow primarily in foreign currency and in which external trade forms a large part of their GDP."
"With perfect capital mobility, a fixed exchange rate prevents a government from using domestic monetary policy to achieve macroeconomic stability."
"The central bank sells foreign currency from its reserves and buys back the domestic money."
"A fixed exchange rate system can be used to control the behavior of a currency, such as by limiting rates of inflation."
"China adopted a slightly more flexible exchange rate system, called a managed exchange rate."
"The European Exchange Rate Mechanism is used on a temporary basis to establish a final conversion rate against the euro from the local currencies of countries joining the Eurozone."
"The central bank adds domestic money into the market by buying back the foreign money, thereby maintaining market equilibrium at the intended fixed value of the exchange rate."
"Small economies that borrow primarily in foreign currency and in which external trade forms a large part of their GDP benefit from a fixed exchange rate system."
"With perfect capital mobility, a fixed exchange rate prevents a government from using domestic monetary policy to achieve macroeconomic stability."