Overview
This series treats a currency peg as an operating system rather than a number on a chart. It traces how the fixed exchange-rate commitment links foreign-exchange transactions to central-bank foreign assets, bank reserves, money-market rates, capital flows, and reserve demand; then tests when frictions shift pressure into funding costs, liquidity, or market depth. It compares policy rates, open-market operations, reserve averaging, standing facilities, refinancing, collateral, and documented designs including Bulgaria, Denmark, Hong Kong SAR, and Saudi Arabia. The central judgment is conditional: credibility depends on visible balance-sheet mechanics, and resilience on timely, well-matched tools that preserve market function. IMF estimates and BIS comparisons remain model-, sample-, period-, and institution-specific, so the framework explains mechanisms and trade-offs rather than proving current performance or a universal design.
Learning outcomes
- A fixed exchange rate links FX intervention to the central bank’s foreign assets and the banking system’s reserve supply.
- Automatic adjustment can be stabilizing, but transaction costs, delays, risk, and shallow markets can shift pressure into rates and bank liquidity.
- Policy rates, liquidity operations, reserve averaging, facilities, and collateral address different shocks and create different trade-offs.
- Credibility and resilience require visible balance-sheet mechanics, workable reserve incentives, functioning markets, and evidence-aware judgments.
Keywords
Preview every chapter · Unlock full text, audio, and video from chapter 4
PlansFAQ
How does a currency peg affect domestic liquidity?
A currency peg affects domestic liquidity because the central bank buys or sells foreign currency in exchange for local-currency bank reserves. Purchases expand reserves; sales contract them, changing money-market conditions unless another operation offsets the movement.
Why can a peg hold while banks face financial stress?
A peg can hold while banks face financial stress when defending the exchange rate shifts pressure into reserves, funding rates, or liquidity rather than the exchange-rate quote. Delayed capital inflows, risk premia, or a shallow interbank market can make the burden persistent.
Which tools help a central bank manage a pegged currency?
The relevant tools are the policy rate, open-market operations, reserve averaging, standing facilities, and refinancing backed by collateral, but each addresses a different transmission problem. Their settings also affect funding costs, market discipline, and central-bank risk.
Do corridor and floor labels fully explain a peg’s liquidity behavior?
No. Corridor and floor labels show where the overnight rate trades relative to facilities, but not the marginal opportunity cost of reserves or their aggregate quantity. Those dimensions better reveal trading incentives and liquidity buffers.
How should the resilience of a currency peg be assessed?
Assess a peg’s resilience by tracing each shock from its source through reserves, rates, flows, bank behavior, and market function. Check whether the response is timely and self-limiting, and whether evidence is theoretical, institutional, modeled, or sample-specific.