Professional Documents
Culture Documents
MACROECONOMICS
(Pegged Currency)
By:
Akash Anil Kamat
(16B103)
Tushar Abhyankar
(16B120)
Yash Verma (16B121)
Contents
1. Introduction............................................................................................................ 3
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1.1. What is Pegging?............................................................................................. 3
1.1.1. Example of the U.S. Dollar.........................................................................3
2. Why do countries peg their currencies?.................................................................3
2.1. List of countries that have pegged their currencies.........................................4
3. Advantages of Pegging Currency...........................................................................4
Increase in Exports and Trade..........................................................................4
Lower Cost of Production................................................................................. 5
Increase in Profitability.................................................................................... 5
Rising standard of living and Economic Growth...............................................5
Protection against currency fluctuations..........................................................5
4. Disadvantages of Pegging Currency.......................................................................5
Need to maintain large reserves......................................................................5
Higher Inflation................................................................................................ 5
Economies may fail.......................................................................................... 5
Other Disadvantages:...................................................................................... 5
5. Examples of Impact of having Pegged Currency....................................................6
5.1. Mexico.............................................................................................................. 6
5.2. Argentine Peso- Adverse Effect........................................................................6
5.3. Hong Kong....................................................................................................... 6
6. References............................................................................................................. 6
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1. Introduction
1.1. What is Pegging?
Pegging or a currency peg is a policy of exchange-rate, implemented by a country
or government. It involves pegging or attaching another country's currency to its
central bank's rate of exchange. Hence it is also referred to as a pegged exchange
rate or a fixed exchange rate. Countries usually peg their currencies to other
countries currency, most popular being the U.S. Dollar or the Euro. That means
the central bank of the country has the intention of controlling the value of its
home currency such that its actual variation mimics the variation of the U.S.
Dollar or Euro.
Currency peg helps exporters and importers to create a steady trading
environment. They know precisely what the exchange rate would be, thereby
limiting effects of uncertainties like interest rates or inflation which could hinder
dealings between countries. However, to sustain the peg, the country must store
lots of foreign currency in hand. Hence most of the countries that peg their
currencies to another countrys currency export a lot to that country. Their
companies receive payments in the foreign currency. They then exchange this
foreign currency for home / local currency in order to compensate their employees
/ workers and their domestic suppliers.
It is advantageous for small nations which generally peg their currencies to the
U.S. dollar or the Euro. The pegged strategy helps stabilize and secure small
economies which would otherwise be unable to withstand the volatility.
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Conversely, if a large and growing economy like India maintains a fixed currency
policy, it would result in an oversized need to buy more and more dollars/euro to
maintain the proper ratio.
The countries that have pegged to the dollar in the Caribbean island like
Bahamas, Bermuda and Barbados have done so because their main source of
income is payments made by the tourists in U.S. dollars. This stabilizes their
economy and makes them less volatile. There are many countries in the Middle
East including Oman, Saudi Arabia and UAE that have pegged their currency to
the U.S. dollar as these oil-rich nations need the U.S. as a major trading partner
for oil. These countries make sure that value of their currency remains stable and
are not impacted by constant change as in the case of floating exchange rate,
when they participate in International trade.
De-pegging is a risk that is faced by the currencies that are pegged. De-pegging is
the removal of a previously existing peg on a currency. De-pegging is done if the
central bank is unable to sustain the peg or if the pegging has caused huge
inflation. In 2015, the Government of Switzerland ended its peg to the Euro with
the Swiss Franc. This resulted in taking the Franc to higher exchange rates against
the Euro and other currencies.
Peg
Country Region Curr. Name Code Peg Rate Rate Since
Curr.
Bahrain Middle East Dinar BHD 0.376 U.S.D 2001
Bulgaria Europe Lev BGN 1.95583 EUR 2002
Central Convertible
Cuba CUC 1 U.S.D 2011
America Peso
Denmark Europe Krone DKK 7.46038 EUR 1999
West African
Niger Africa XOF 655.957 EUR 1999
CFA Franc
Central
Panama Balboa PAB 1 U.S.D 1904
America
Saudi
Middle East Riyal SAR 3.75 U.S.D 2003
Arabia
United Arab
Middle East Dirham AED 3.6725 U.S.D 1997
Emirates
South
Venezuela Bolivar VEB 6.3 U.S.D 2013
America
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Increase in Profitability
If the countrys goods are more competitive, it will result in more demand from
foreign countries. More demand will result in more exports and then in higher
profitability. One more contributor to profitability is lower cost of production. If
your cost is lower it is obvious that your bottom line would be higher.
Higher Inflation
As more reserves are required to be maintained, the overall money supply in
the country increases. To create equilibrium, demand for money increases.
Thus, this results in the overall price level to rise i.e. inflation. E.g. Chinese CPI
increased to 5% in December 2010.
Other Disadvantages:
Based on Mundell-Fleming model, if a country tightens its monetary policy,
interest rates rise causing foreign investors to invest largely, thereby causing
surplus in Balance of Payments. In order to maintain the peg, the central bank
buys foreign money in exchange for domestic money, causing home money
stock to increase. Hence the original monetary contraction gets reversed and
interest rates are pushed back to initial rates. Hence a domestic monetary
policy cannot be used to implement macroeconomic stability in case of
countries with pegged currency
While some small countries peg their currencies to a larger countrys to create
stability, doing so exposes their currency to the same risks the larger country
faces.
6. References
1. http://www.investopedia.com/terms/c/currency-peg.asp
2. http://www.investopedia.com/video/play/how-does-currency-peg-work
3. https://www.thebalance.com/what-is-a-peg-to-the-dollar-3305925
4. Bloomberg