Currency Peg

Currency peg is a term used to define the control of the value of a currency by relating it to another currency. US dollar is the most common currency against which other currencies are pegged. A pegged exchange rate is more commonly known as a fixed exchange rate. Pegged exchange rate relates to the value of a particular currency when it is measured against another currency, basket of currencies or against gold. Contrary to this we have a floating exchange rate.

A number of economists prefer a floating exchange rate to pegged or fixed exchange rate. Responsiveness of floating exchange rates to fluctuations in foreign exchange market is a major reason economists’ prefer it over pegged exchange rate. Countries opting for a pegged exchange rate must adopt policies for maintaining peg, otherwise it could lead to damaging devaluation. Adopting a fixed exchange rate for too long a time period can have an adverse effect on an economy, as has been observed from the Asian financial crisis.

Floating Exchange Rate

Supply and demand in private market influences floating exchange rate. It is also referred to as “self-correcting” exchange rate since any discrepancy between supply and demand is automatically addressed in the market.

Maintaining Peg

A government maintains a pegged exchange rate for its currency by purchase and sale of currency in the open market. A depreciation in value of a currency is addressed by purchasing it off the market. In case of appreciation in the value of a currency, the opposite measure is adopted.

Devaluation

Currency devaluation or lowering of the value of a currency is used as a deliberate method to ensure cheaper exports and costlier imports. Countries like Argentina and Mexico had failed to maintain pegged exchange rate and that led to a damaging devaluation of their currency.

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