Next video:
Loading the player...

A pegged exchange rate occurs when one country fixes its currency’s value to the value of another country’s currency. It makes the exchange rate between the two countries constant and stable. But pegging an exchange rate has both pros and cons.

The biggest advantages come from the effect it has on a country’s exports and trade, especially between a nation with low production costs and another country with a stronger currency. A richer, more mature nation may choose to produce its goods in a less mature nation, where production costs are smaller. When those less mature nations translate their earnings into their domestic currencies, they make a larger profit, creating a win/win situation for both countries.

A pegged exchange rate also supports a rising standard of living and economic growth. And it protects a nation from volatile swings in the foreign exchange rate, which reduces the likelihood of a currency crisis.

Among the disadvantages is the large amount of reserves a central bank has to maintain to make a pegged exchange rate work. Those large reserves can spark higher inflation, which causes prices to rise, creating problems for a country’s economic stability. The central bank must also buy or sell its currency on the open market to keep its value in line with the pegged nation’s currency.

Despite the negatives, many major and minor economies favor a pegged exchange rate. A country can gain trading advantages while protecting its economic interests, but these advantages come at a price.

  1. No results found.
Related Articles
  1. Trading

    6 factors that influence exchange rates

    Aside from interest rates and inflation, the exchange rate is one of the most important determinants of a country's level of economic health.
  2. Insights

    How Does a Currency Peg Work?

    When a government initiates a currency peg, it pegs its currency’s value to that of another country.
  3. Trading

    Main Factors that Influence Exchange Rates

    The exchange rate is one of the most important determinants of a country's relative level of economic health and can impact your returns.
  4. Trading

    Top Exchange Rates Pegged to the U.S. Dollar

    From the end of World War II until around 1971, all countries in the IMF pegged their currencies to the U.S. dollar. Today, many still do.
  5. Trading

    Dollarization Explained

    Find out how fledgling economies can find some stability in their currency and attract foreign investment.
  6. Trading

    What causes a currency crisis?

    Find out what can cause a currency to collapse and what central banks can do to help in times of currency crisis.
  7. Insights

    A Primer On Reserve Currencies

    For nearly a century, the U.S. dollar has served as the world's premier reserve currency, but the future is uncertain.
  8. Trading

    Currency fluctuations: How they effect the economy

    Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies. Read on for what effects these changes can have.
  9. Trading

    6 top-traded currencies and why they're so popular

    Every currency has specific features that affect its underlying value and price movements in the forex market. Learn why these currencies are especially popular for trading.
Trading Center