Currency Peg

A currency peg (fixed exchange rate) is a monetary policy in which a country's central bank maintains its currency at a fixed rate relative to another currency (typically the U.S. dollar or euro) or a basket of currencies. The central bank must actively buy or sell its own currency in foreign exchange markets and maintain sufficient foreign reserves to defend the peg. Pegs provide exchange rate stability, reduce transaction costs for trade, and can import monetary credibility from the anchor currency. However, they also limit monetary policy independence (the "impossible trinity" or trilemma states a country cannot simultaneously maintain a fixed exchange rate, free capital movement, and independent monetary policy). Currency pegs can collapse dramatically if reserves are depleted or if the fixed rate becomes misaligned with economic fundamentals, as seen with the British pound in 1992 or the Thai baht in 1997.