- Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of
exchange rate regimewherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.
A fixed exchange rate is usually used to stabilize the value of a currency, vis-a-vis the currency it is pegged to. This facilitates trade and investments between the two countries, and is especially useful for small economies where external trade forms a large part of their GDP.
It is also used as a means to control
inflation. However, as the reference value rises and falls, so does the currency pegged to it. In addition, a fixed exchange rate prevents a government from using domestic monetary policyin order to achieve macroeconomic stability.
A former president of the Federal Reserve Bank of New York described fixed currencies as follows:
In certain situations, fixed exchange rates may be preferable for their greater stability. For example, the
Asian financial crisiswas improved by the fixed exchange rate of the Chinese renminbi, and the IMFand the World Banknow acknowledge that Malaysia's adoption of a peg to the US dollar in the aftermath of the same crisis was highly successful. Following the devastation of World War II, the Bretton Woods systemallowed Western Europeto have fixed exchange rates until 1970 with the US dollar. [http://www-econ.stanford.edu/faculty/workp/swp99020.pdf#search=%22western%20europe%20fixed%20exchange%20rate%201970%20us%20dollar%22]
With regard to the Asian financial crisis, others argue that the fixed exchange rates (implemented well before the crisis) had become so immovable that it had masked valuable information needed for a market to function properly. That is, the currencies did not represent their true market value. This masking of information created volatility which encouraged speculators to "attack" the pegged currencies and as a response these countries attempted to defend their currency rather than allow it to devalue. These economists also believe that had these countries instituted floating exchange rates, as opposed to fixed exchange rates, they may very well have avoided the volatility that caused the Asian financial crisis in the first place. Countries like Malaysia adopted increased capital controls, believing that the volatility of capital was the result of technology and globalization, rather than fallacious macroeconomic policies. This resulted not in better stability and growth in the aftermath of the crisis, but sustained pain and stagnation.Fact|date=September 2008
Countries adopting a fixed exchange rate must exercise careful and strict adherence to policy imperatives, and keep a degree of confidence of the
capital marketsin the management of such a regime, or otherwise the peg can fail. Such was the case of Argentina, where unchecked state spending and international economic shocks disbalanced the system and ended up forcing an extremely damaging devaluation(see Argentine Currency Board, Argentine economic crisis, and the 1994 economic crisis in Mexico). On the opposite extreme, China's fixed exchange rate with the US dollar until 2005 led to China's rapid accumulation of foreign reserves, placing an appreciating pressure on the Chinese yuan.
Maintaining a fixed exchange rate
Typically, a government wanting to maintain a fixed exchange rate does so by either buying or selling its own currency on the open market. This is one reason governments maintain reserves of foreign currencies. If the exchange rate drifts too far below the desired rate, the government buys its own currency off the market using its reserves. This places greater demand on the market and pushes up the price of the currency. If the exchange rate drifts too far above the desired rate, the opposite measures are taken.
Another, less used means of maintaining a fixed exchange rate is by simply making it illegal to trade currency at any other rate. This is difficult to enforce and often leads to a
black marketin foreign currency. Nonetheless, some countries are highly successful at using this method due to government monopolies over all money conversion. This is the method employed by the Chinese government to maintain a currency peg or tightly banded float against the US dollar.Fact|date=September 2007 Throughout the 1990s, China was highly successful at maintaining a currency peg using a government monopoly over all currency conversion between the Yuan and other currenciesFact|date=September 2007.
The main criticism of a fixed exchange rate is that flexible exchange rates serve to automatically adjust the
balance of trade.Fact|date=March 2007 When a trade deficit occurs, there will be increased demand for the foreign (rather than domestic) currency which will push up the price of the foreign currency in terms of the domestic currency. That in turn makes the price of foreign goods less attractive to the domestic market and thus pushes down the trade deficit. Under fixed exchange rates, this automatic re-balancing does not occur.
* Tiwari, Rajnish (2003): "Post-Crisis Exchange Rate Regimes in Southeast Asia", Seminar Paper, University of Hamburg. ( [http://www.rrz.uni-hamburg.de/RRZ/R.Tiwari/papers/exchange-rate.pdf PDF] )
Linked exchange rate
Wikimedia Foundation. 2010.
Look at other dictionaries:
fixed exchange rate — A country s decision to tie the value of its currency to another country s currency, gold (or another commodity), or a basket of currencies . Bloomberg Financial Dictionary * * * fixed exchange rate fixed exchange rate ➔ exchange rate * * * A… … Financial and business terms
Fixed Exchange Rate — A country s exchange rate regime under which the government or central bank ties the official exchange rate to another country s currency (or the price of gold). The purpose of a fixed exchange rate system is to maintain a country s currency… … Investment dictionary
fixed exchange rate — A rate of exchange between one currency and another that is fixed by government and maintained by that government s economic policy and its buying or selling its currency to support or depress it. Compare: floating exchange rate … Accounting dictionary
fixed exchange rate — A rate of exchange between one currency and another that is fixed by government and maintained by that government s economic policy and its buying or selling its currency to support or depress it. Compare floating exchange rate … Big dictionary of business and management
fixed exchange rate — /fɪkst ɪks tʃeɪndʒ reɪt/ noun a rate of exchange of one currency against another which cannot fluctuate, and can only be changed by devaluation or revaluation … Dictionary of banking and finance
Fixed-exchange rate — A country s decision to tie the value of its currency to another country s currency, gold (or another commodity), or a basket of currencies. The New York Times Financial Glossary … Financial and business terms
fixed exchange rate — cambio fisso In un regime di cambi fissi, le autorità monetarie di un Paese sono pronte a vendere e ad acquistare le loro divise ad un cambio prefissato in termini di altre valute. Questa forma di quotazione venne inaugurato con l accordo di… … Glossario di economia e finanza
Fixed exchange-rate system — Foreign exchange Exchange rates Currency band Exchange rate Exchange rate regime Exchange rate flexibil … Wikipedia
Exchange rate — Foreign exchange Exchange rates Currency band Exchange rate Exchange rate regime Exchange rate flexibility Dollarization Fixed exchange rate Floating exchange rate Linked exchange rate Managed float regime Markets Foreign exchange market Futures… … Wikipedia
Exchange rate — The price of one country s currency expressed in another country s currency. The New York Times Financial Glossary * * * exchange rate exˈchange rate noun [countable] FINANCE the price at which one currency can be bought with another: • If the… … Financial and business terms