The Basics
- Simple definition: A policy where a country fixes its exchange rate to another currency or a basket of currencies.
- Core idea: Tying your currency’s value to a stable anchor helps gain credibility and stability.
- Think of it as: Hitching your wagon to a stronger horse.
What It Actually Means
A currency peg means the central bank commits to buying and selling its currency at a fixed rate against an anchor currency. Examples include the Saudi riyal pegged to the dollar and the Hong Kong dollar pegged to the US dollar. Benefits include reduced uncertainty for trade, anchoring inflation expectations, and imposing discipline. Costs include losing independent monetary policy because the country must follow the anchor country’s interest rates, requiring large reserves to defend the peg, and vulnerability to speculative attacks if the peg becomes misaligned. Pegs can be hard, meaning fixed, or soft, meaning crawling bands.
Example
If Pakistan pegged the rupee to the dollar at 280, the State Bank would have to intervene whenever market pressure pushed the rate away from that level. It would sell dollars if the rupee weakened and buy dollars if the rupee strengthened. This would require massive reserves, and the country would lose its ability to set interest rates independently.
Why It Matters (2026)
Pegs are controversial. Some Gulf states maintain them successfully, while others, such as Argentina, have suffered crises. Pakistan has floated the rupee but periodically intervenes. Understanding pegs helps evaluate exchange rate policy options.
See also
Fixed Exchange Rate • Exchange Rate Regime • Currency Board • Speculative Attack • Reserves
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