In this work an understanding for fixed exchange rates shall be developed, in order to be able to apply it in relation to flexible ones.
Currency policy is often viewed in connection with monetary policy, and is a complex topic with many different approaches to determine the exchange rate; as it is a relative and not absolute price. In recent years exchange rates have played an increasing part in financial crises.
In 1923 a change in the dominant exchange system - the gold standard - occurred; from this time there were two exchange rate systems – fixed and flexible. Since then there has been an ongoing discussion as to whether fixed exchange rate systems are the better way of reaching countries’ economic goals. A crisis can be also a starting point to think about the pros and cons of the relevant exchange rate system and if it was a cause as well.
This work tries to find an answer to the fundamentals of currency peg from looking at the history to better predict the future, finding some ideas as to what should be considered in determining the exchange rate system.
The subject of this work is the fixed exchange rate system and will focus only on the technical aspect of the exchange rate and not the influences to which politicians are exposed.
The aim of this work is to obtain an overview regarding whether a currency peg is good or bad for a country, through taking a short look on the Mexican crises to find the main trend, namely if a fixed or flexible exchange rate is better.
To answer the question, exchange rate systems will firstly be defined and the different types and countries using it will be described. Then the history, the gold standard, and the mechanism of fixed exchange rate systems and development of crises will be considered. Chapter three will look at the advantages and disadvantages of a currency peg including a brief examination on the Mexican crises as defined by the literature. In the final chapter a conclusion will be reached whether a currency peg is a favourable system.
Table of Contents
1 Introduction
2 Fundamentals of a currency peg
2.1 Fundamentals and definitions of exchange rate systems
2.2 Types of fixed exchange rate systems
2.3 Current countries with a currency peg
2.4 History of fixed exchange rate systems – gold standard
2.5 Fixed exchange rate mechanism and development of crises
3 Advantages and disadvantages of a currency peg
3.1 Advantages of a currency peg
3.2 Disadvantages of a currency peg
4 Conclusion
Objectives and Topics
This paper aims to investigate the fundamental mechanics of a currency peg and evaluate whether such a system is beneficial or detrimental for a country, specifically by analyzing historical data and examining the case of the Mexican currency crises to determine the viability of fixed versus flexible exchange rate systems.
- Fundamental definitions and types of exchange rate systems
- Historical context of the gold standard and its mechanisms
- Technical analysis of the fixed exchange rate mechanism and crisis development
- Evaluation of the comparative advantages and disadvantages of currency pegs
- Investigation of the Mexican currency crisis (1994-1995) as a case study
Excerpt from the Book
2.5 Fixed exchange rate mechanism and development of crises
Only two of three options, which are financial integration, fixed exchange rate, and monetary autonomy, can be fulfilled at any one time (vgl. Frieden, 2015, p. 5–6). According to the Mundell-Fleming model of free movement of capital, either monetary independence or fixed exchange rate is achievable. If in a fixed exchange rate system, the money supply is increased there is no impact as the raise is compensated through the outflow of capital. Another, currently minor with technological progress, option is the limitation of mobility of the capital through the monetary authorities (vgl. Frieden, 2015, p. 5–6).
The development of exchange rates is difficult to determine (vgl. Jarchow, 2002, p. 498-499). Expectations determine exchange rates, thus if the expectations regarding the prospective exchange rates are changing it will reflect in the actual exchange rate since the parties will sell or buy currencies. Further, the assessment of future exchange rates is difficult as the parties are not certain. In case of an appreciation or depreciation of the domestic currency, the parties will follow other supposedly more knowledgeable parties with selling or buying, and as a result the movement will increase. In a fixed exchange rate system, there can be one-sided speculation as a result of the accumulating need for adaptation hence no up and down movements of the exchange rate. Leeway for autonomous monetary policy is possible in a flexible exchange rate system, but not in a fixed exchange rate (vgl. Jarchow, 2002, p. 498-499). In the long-term both countries need a comparable monetary policy (vgl. Frey, 2004, p. 87) and interest rates are set through the circumstances in a financial open economy (vgl. Frieden, 2015, p. 14).
Summary of Chapters
1 Introduction: This chapter outlines the motivation for the study, including the recent shift in the Swiss exchange rate, and defines the research scope concerning technical aspects of exchange rate systems.
2 Fundamentals of a currency peg: This section details the theoretical foundations, the types of exchange rate systems including hard and soft pegs, the history of the gold standard, and the mechanisms behind crisis development.
3 Advantages and disadvantages of a currency peg: This chapter evaluates the pros and cons of fixed systems, discusses fiscal regulation and competitiveness, and analyzes the Mexican currency crisis of 1994-1995 as a practical example.
4 Conclusion: The final chapter summarizes the findings, noting that while pegs can help reduce inflation in the short-term, they pose long-term risks such as reduced competitiveness and vulnerability to crises.
Keywords
Currency peg, Fixed exchange rate, Monetary policy, Gold standard, Exchange rate system, Financial crisis, Hard peg, Soft peg, Inflation, Capital inflow, Balance of payments, Economic stability, Currency devaluation, Market speculation, Mexican crisis
Frequently Asked Questions
What is the primary focus of this paper?
The paper explores the concept of a currency peg, examining how these systems function, their historical context, and the advantages and disadvantages associated with fixing a currency's value.
What are the central themes discussed in this work?
The central themes include the mechanics of exchange rate systems, the trade-offs between monetary autonomy and fixed rates, the historical influence of the gold standard, and the factors leading to currency crises.
What is the primary research objective?
The primary objective is to obtain an overview of whether a currency peg is favorable for a country by examining literature and historical case studies like the Mexican crisis.
Which scientific method is applied here?
The author employs a qualitative literature research method, analyzing recent and historical sources to synthesize the current understanding of currency systems.
What does the main body of the work cover?
The main body covers definitions of exchange rate systems, types of pegs (hard and soft), the history and breakdown of the gold standard, and a detailed analysis of the risks and benefits of maintaining a peg.
Which keywords characterize the work?
Key terms include currency peg, fixed exchange rate, monetary policy, financial crisis, inflation, and capital flows.
How does the Mundell-Fleming model relate to the topic?
The model is used to explain the "trilemma" of international finance, stating that a country cannot simultaneously have a fixed exchange rate, free capital movement, and autonomous monetary policy.
What specific lessons are drawn from the Mexican crisis of 1994-1995?
The study uses the Mexican crisis to illustrate how capital inflows and subsequent sudden capital flight, combined with a delayed depreciation of the currency, can lead to the abandonment of a peg and financial distress.
- Arbeit zitieren
- Anja Berndt (Autor:in), 2019, Understanding the concept of a currency peg, München, GRIN Verlag, https://www.grin.com/document/980933
