Pegged currency
Family IX · Macro
Not to be confused with forex currency trading, commodity currency, currency devaluation.
Pegged currency describes a monetary arrangement in which a country's authorities set a fixed exchange rate against a reference — commonly the US dollar, the euro, or a trade-weighted basket — and defend that rate rather than letting the market set it. The peg can be hard, as in a currency board, or soft, as in a crawling band that permits gradual movement. The defining feature is a stated parity that policy is committed to maintaining.
How a peg is maintained
A central bank holds the peg by buying or selling its own currency against the reference at or near the announced rate. To sell the domestic currency it must hold sufficient foreign reserves; to buy it back it can issue domestic liabilities. A currency board goes further, backing the entire monetary base with foreign assets and removing discretion over the money supply.
Pegs vary in flexibility. A conventional peg keeps the rate within a narrow band. A crawling peg adjusts the parity on a schedule or in response to inflation differentials. A target zone allows wider fluctuation. The International Monetary Fund classifies these as distinct exchange-rate arrangements, and the classification of any given country can change over time.
Worked example: defending a peg
The arithmetic shows why pegs under sustained pressure often end in a change of parity or a float: reserves are finite, while the market's demand for foreign currency is not.
Consequences and risks
A peg imports the monetary policy of the reference currency. If the anchor country tightens while the pegged economy needs easing, domestic conditions may deteriorate. Persistent inflation above the anchor's rate erodes competitiveness and invites speculative pressure.
Breaking a peg can take the form of a currency devaluation — a discrete downward reset of the parity — or a move to a floating rate. The choice, and the size of any devaluation, is a policy decision that varies by country and circumstance.
Often confused with
- forex currency trading
- This is the activity of buying and selling currency pairs for profit, whereas a pegged currency is a monetary regime; the visible sign is that a peg is described by a central bank's policy, not by a trader's position.
- commodity currency
- A commodity currency tends to move with the price of a major export such as oil or iron ore, while a pegged currency is held at a fixed rate by policy; the visible sign is that the commodity currency fluctuates daily on market prices, whereas the pegged one does not.
- currency devaluation
- A devaluation is a one-off official reduction in a peg's parity, not the peg itself; the visible sign is a step change in the quoted rate rather than a rate held constant.