HARD PEG: Establishing a fixed exchange rate between one national currency (usually that of a small country) and another national currency (usually that of an industrial power). One country, in other words, "pegs" the value of its currency to the value of another currency.
What is a peg in economics?
A currency peg is a country or government's exchange rate policy whereby it attaches, or pegs, the central bank's rate of exchange to another country's currency. Also referred to as a fixed exchange rate or a pegged exchange rate, a currency peg stabilizes the exchange rate between countries.
What is pegging in commodity trading?
A less known definition of pegging occurs mainly in futures markets and entails a commodity exchange linking daily trading limits to the previous day's settlement price so as to control price fluctuations.
Is a currency peg challenging to maintain and distort markets?
However, a currency peg can be challenging to maintain and distort markets if it is too far removed from the natural market price. A currency peg is a policy in which a national government sets a specific fixed exchange rate for its currency with a foreign currency or basket of currencies.
What is a soft peg?
A soft peg describes the type of exchange rate regime applied to a currency to keep its value stable against a reserve currency or a basket of currencies. A soft peg describes the type of exchange rate regime applied to a currency to keep its value stable against a reserve currency or a basket of currencies.
What are the different types of currency peg?
There are four main types of exchange rate regimes: freely floating, fixed, pegged (also known as adjustable peg, crawling peg, basket peg, or target zone or bands ), and managed float.
Why would a country want to peg their currency?
The dollar peg is used to stabilize exchange rates between trading partners. A country that pegs its currency to the U.S. dollar seeks to keep its currency's value low. A lower value currency vis-à-vis the dollar allows the country's exports to be very competitively priced.
Which countries use hard peg exchange rate?
Most of the Caribbean islands—Aruba, Bahamas, Barbados, and Bermuda, to name a few—peg their currencies to the U.S. dollar because their main source of income is derived from tourism paid in dollars. Fixing to the U.S. dollar stabilizes their economies and makes them less volatile.
What does pegged mean in business?
What Is Pegging? The term pegging refers to the practice of attaching or tying a currency's exchange rate to another country's currency. Pegging often involves preset ratios, which is why it's called a fixed rate.
How do pegged currencies work?
A currency peg is a policy in which a national government sets a specific fixed exchange rate for its currency with a foreign currency or a basket of currencies. Pegging a currency stabilizes the exchange rate between countries. Doing so provides long-term predictability of exchange rates for business planning.
Is currency pegging good?
By pegging its currency, a country can gain comparative trading advantages while protecting its own economic interests. A pegged rate, or fixed exchange rate, can keep a country's exchange rate low, helping with exports. Conversely, pegged rates can sometimes lead to higher long-term inflation.
What is hard peg and soft peg?
Key Concepts and Summary In a soft peg exchange rate policy, a country's exchange rate is usually determined in the foreign exchange market, but the government sometimes intervenes to strengthen or weaken the exchange rate. In a hard peg exchange rate policy, the government chooses an exchange rate.
What is the US dollar backed by?
Why Is Fiat Money Valuable? In contrast to commodity-based money like gold coins or paper bills redeemable for precious metals, fiat money is backed entirely by the full faith and trust in the government that issued it. One reason this has merit is that governments demand that you pay taxes in the fiat money it issues.
Which of the following is an example of a pegged currency?
The correct answer is D (Chinese Yuan). Pegged currency has been set to be fixed in terms of exchange rates with other foreign currencies.
How many countries peg their currency to the dollar?
Over 66 countries have their currencies pegged to the US dollar. For instance, most Caribbean nations, such as the Bahamas, Bermuda and Barbados, peg their currencies to the dollar because tourism, which is their main source of income, is mostly conducted in US dollars.
How do currency pegs affect forex trading?
Currency pegs affect forex trading by artificially stemming volatility . Countries will experience a particular set of problems when a currency is pegged at an overly low exchange rate.
Why do we use currency pegs?
The primary motivation for currency pegs is to encourage trade between countries by reducing foreign exchange risk. Profit margins for many businesses are low, so a small shift in exchange rates can eliminate profits and force firms to find new suppliers.
What happens when a currency is pegged at an overly high rate?
Another set of problems emerges when a currency is pegged at an overly high rate. A country may be unable to defend the peg over time. Since the government set the rate too high, domestic consumers will buy too many imports and consume more than they can produce.
What are the disadvantages of a pegged currency?
The central bank of a country with a currency peg must monitor supply and demand and manage cash flow to avoid spikes in demand or supply. These spikes can cause a currency to stray from its pegged price.
Why are pegged currencies important?
Pegged currencies can expand trade and boost real incomes, particularly when currency fluctuations are relatively low and show no long-term changes. Without exchange rate risk and tariffs, individuals, businesses, and nations are free to benefit fully from specialization and exchange.
What happens when a currency peg is too low?
An overly low currency peg keeps domestic living standards low, hurts foreign businesses, and creates trade tensions with other countries. An artificially high currency peg contributes to the overconsumption of imports, cannot be sustained in the long run, and often causes inflation when it collapses.
What happens when the peg collapses?
When a currency peg collapses, the country that set the peg too high will suddenly find imports more expensive. That means inflation will rise, and the nation may also have difficulty paying its debts.
