Peg

In terms of economics and currency, to “peg” a currency means to tie its exchange rate to a specific value. This value can be a set rate against another currency (or multiple currencies), a basket of currencies, or a commodity such as gold. Pegging a currency can provide stability and predictability for international trade, but it also limits a country’s monetary policy options.

Here are the primary types of currency pegs:

1. Hard Pegs: This implies a firm commitment to a single fixed exchange rate. Examples include currency boards, dollarization, and monetary unions.
2. Soft Pegs: This implies a commitment to a general path of the exchange rate, which includes horizontal bands, crawling pegs, and adjustable pegs.

A country may decide to peg its currency for various reasons. It may do so to stabilize the exchange rate, reduce volatility, and create an environment that is conducive to trade. Countries with less developed financial systems often peg to the currency of a larger trading partner or to a basket of currencies of trading partners.

However, maintaining a currency peg can be challenging, especially in the face of economic crises or speculative attacks, where investors bet against the currency’s ability to maintain its peg. In such circumstances, the country’s central bank must be prepared to defend the peg by using its foreign currency reserves to buy back its own currency. If the central bank runs out of reserves, it may be forced to abandon the peg, which can result in a sharp devaluation and economic instability.