Currency Peg
IntermediateA currency peg is a policy in which a country fixes its currency's exchange rate to another currency, usually a major one such as the US dollar or the euro, or to a basket of currencies.
A currency peg is a form of fixed exchange rate. The central bank commits to keeping the exchange rate at, or within a narrow band around, a set level by buying and selling currencies in the foreign exchange market.
Pegs can take different forms. A hard peg keeps the exchange rate fixed, sometimes through a currency board that backs every unit of domestic currency with foreign reserves. A soft peg allows the rate to move within a band or be adjusted gradually over time.
For example, several Gulf states peg their currencies to the US dollar, which makes sense because their main export, oil, is priced in dollars. Some countries in Central and Eastern Europe have pegged their currencies to the euro.
Pegs offer stability and can help build confidence, particularly for countries with a history of high inflation. But they limit independent monetary policy and require large reserves. If a peg comes under pressure and the central bank's reserves run low, it may be forced to devalue or abandon the peg, sometimes causing financial turmoil.
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