In Finance, What Is Pegging?

The pegged exchange rate system refers to an exchange rate system in which a country maintains a fixed parity rate with a foreign currency or a basket of currencies.

Pegged exchange rate

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Reserve balances will rise (or fall) strictly in accordance with changes in the total balance of payments, that is, offsetting the net surplus or

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Pegged exchange rate economy expansion period

The reason for the collapse of the pegged exchange rate is domestic. The supply of domestic products is always smaller than the demandor the demand continues to exceed the supply, that is, the positive shock of demand, or the decline in supply capacity, that is, the negative shock of supply.

The former include:

1. The government implemented a deficit fiscal policy to stimulate the economy when the economy was fully employed, which led to the deterioration of the current account and caused Krugman's model government in 1979 to be forced to abandon the exchange rate after the foreign exchange reserves dried up. The balance of payments crisis situation;

2. The deterioration of the current account indicates an increase in external debt, and a Keynesian government may actively devalue in hopes to achieve actual depreciation, but if the price is sticky, the effect of nominal depreciation will eventually be the result of inflation under full employment conditions. erosion;

3. High inflation in the private sector in the context of inertial inflation is expected to force the government to depreciate, which is a "self-promoting" devaluation in the commodity market;

4. When governing inertial inflation, the government should convince the private sector of its determination to counter inflation. It can introduce a pegged exchange rate and use it as a "nominal anchor" of anti-inflationary monetary policy.

The latter include:

1. Debt-consumption consumption under negative supply shocks deteriorated the current account, and it is difficult to sustain the exchange rate when foreign capital no longer flows in. This is the situation of the Latin American debt crisis in 1982;

2. The existence of banks makes the negative supply shock manifest as the rise of bad and bad debts of banks. Banks are generally unwilling to use their capital to write down, but rather borrow foreign debt to ensure payment to depositors. When banks are about to go bankrupt, the government usually Will perform the function of a lender of last resort, which will cause fiscal deficits and threaten the stability of the pegged exchange rate by means of Krugman-style speculative shocks;

3. In the process of introducing foreign capital for industrialization, developing countries will face initial external debt growth, deteriorating current accounts, and appreciation of the real exchange rate. If investment projects cannot ultimately generate export earning capacity, the country will be forced to repay once foreign capital no longer flows in. The principal and interest of foreign debt may cause the depreciation of the exchange rate.

Pegged exchange rate economy contraction period

Assuming that the initial state of the economy is internal or external balance or recession rather than overheating, the initial pegged exchange rate will be threatened in the following situations:

1. Higher interest rates in anchor currency countries will force local currency interest rates to increase in order to maintain the pegged exchange rate, which will cause a recession, so the government may actively devalue, such as the crisis of the European exchange rate mechanism in 1992;

2. The appreciation of the anchor currency relative to the currencies of other major industrialized countries will increase the actual effective exchange rate of the domestic currency; the depreciation of the currencies of the exporting competitors relative to the local currency will reduce the export demand of the country through the effect of the cross-price elasticity of the demand for exports All of these situations may cause the local currency to depreciate voluntarily or spontaneously. This is the situation of the RMB exchange rate in 1997;

3. Stagflation may occur when governing inertial inflation-the private sector is unwilling to lower its inflation expectations, so nominal wages and product prices, even the inflation rate, cannot be reduced. One way is to reduce inflation expectations to negative values. It is deflation and depression. Obviously, the output cost is too high. Another method is to devalue nominally and depreciate the real exchange rate rapidly. This can transform the output structure. More profitable, so that the non-tradable goods sector loses production resources that are unemployed due to reduced demand and transfers to the export goods sector to achieve full employment. It can also transform the structure of expenditures-allowing domestic and foreign residents to spend more. Improving the current account on domestic products and bringing the economy out of recession;

4. After 1997, the RMB did not depreciate and its real effective exchange rate appreciated. The impact on exports combined with some other institutional factors constituted a serious negative aggregate demand shock, and even caused the economy to fall into a "liquidity trap." To solve this problem, a nominal devaluation method can be used, which can devalue the real effective exchange rate of the RMB, thereby expanding aggregate demand;

5. Unsuccessful industrialization overvalues the real exchange rate under the pegged exchange rate. If a currency crisis is triggered, it will cause excessive depreciation of the domestic currency, capital outflows, and shrinking domestic demand. At this time, it is necessary to maintain "soft currency" to facilitate export growth, and It is necessary to keep interest rates low in order to implement an expansionary policy. This is not available under the condition of free capital flow. Only by implementing capital controls can the recession be mitigated. This can be described as the "heretical" adjustment plan opposed to orthodox economics. This method was used in 1998.