Pegged Currency

A pegged currency (also called a fixed exchange rate) is one whose value is tied to another currency, a basket of currencies, or sometimes a commodity like gold. The country's central bank commits to maintaining the exchange rate at or near the designated level by buying or selling its own currency in the foreign exchange market and adjusting monetary policy as needed.

There are several forms of currency pegs:

• Hard peg: The exchange rate is fixed at a specific level with very little or no permitted fluctuation. Examples include the Hong Kong dollar, pegged to the U.S. dollar at approximately 7.80 since 1983, and the Saudi riyal, pegged at 3.75 to the dollar
• Crawling peg: The exchange rate is adjusted gradually over time, usually to account for inflation differentials. China used a crawling peg mechanism for the yuan for many years
• Currency board: An extreme form of hard peg where the monetary authority must hold foreign currency reserves equal to 100% of the domestic currency in circulation. Bulgaria and Hong Kong operate currency boards
• Band peg: The currency is allowed to fluctuate within a defined range (band) around the peg. China currently maintains a managed band system for the yuan

Countries adopt pegs for several reasons:

• Trade stability: Fixed rates reduce exchange rate uncertainty for international commerce
• Inflation control: Pegging to a stable currency (like the USD) can help import monetary discipline and low inflation
• Investor confidence: Predictable exchange rates attract foreign investment
• Economic integration: Regional pegs can facilitate closer economic ties, as the European Exchange Rate Mechanism did before the euro

However, maintaining a peg comes with significant costs and risks. The central bank must hold substantial foreign currency reserves to defend the peg during periods of market pressure. The country sacrifices independent monetary policy — it cannot freely adjust interest rates because doing so might undermine the peg. If the peg becomes unsustainable due to diverging economic fundamentals, the eventual abandonment can be violent, as seen with the British pound's ejection from the ERM in 1992, the Thai baht's collapse in 1997 triggering the Asian financial crisis, and the Swiss franc's de-pegging in 2015.