Currency Peg

Under a free-floating system, exchange rates move with supply and demand. A peg overrides that mechanism: the authorities declare that one unit of their currency equals, say, a specific number of US dollars, and they commit to defending that rate. Saudi Arabia's riyal and Hong Kong's dollar are well-known examples of long-standing pegs. You can see how pegged currencies appear on the currencies page — their rates barely move day to day.

Defending a peg requires tools. If the currency faces selling pressure and would naturally weaken, the central bank buys its own currency using foreign-exchange reserves — stockpiles of foreign currency, typically dollars. Buying domestic currency removes it from circulation and props up its price. If pressure pushes the other way, the central bank sells its currency, accumulating reserves. This is why reserve levels are closely watched as a signal of a peg's durability.

Pegs offer predictability — businesses can plan cross-border contracts without currency risk — but they surrender monetary independence. The central bank can no longer freely set interest rates for domestic conditions; rates must stay aligned with the anchor country's to prevent capital fleeing or flooding in. The currency crises guide explores what happens when that alignment breaks down.

A common confusion is between a hard peg, where the rate is legally fixed with no band, and a soft peg or managed float, where authorities target a range but allow some movement. China's renminbi, for example, operates within a managed band rather than a strict fixed rate.