Exchange Rate Policies

Here, you will build on your primary knowledge of the different currency exchange rates and learn more about floating currencies and pegged currencies. What is the difference between a soft-pegged and a hard-pegged currency? What does "dollarization" mean?

Exchange Rate Policies

Learning Objectives

By the end of this section, you will be able to:

  • Differentiate among a floating exchange rate, a soft peg, a hard peg, and a merged currency
  • Identify the tradeoffs that come with a floating exchange rate, a soft peg, a hard peg, and a merged currency

Exchange rate policies come in a range of different forms listed in Figure 1: let the foreign exchange market determine the exchange rate; let the market set the value of the exchange rate most of the time, but have the central bank sometimes intervene to prevent fluctuations that seem too large; have the central bank guarantee a specific exchange rate; or share a currency with other countries. Let’s discuss each type of exchange rate policy and its tradeoffs.

Figure 1. A Spectrum of Exchange Rate Policies. A nation may adopt one of a variety of exchange rate regimes, from floating rates in which the foreign exchange market determines the rates to pegged rates where governments intervene to manage the value of the exchange rate, to a common currency where the nation adopts the currency of another country or group of countries.

Source: Rice University, https://opentextbc.ca/principlesofeconomics/chapter/29-4-exchange-rate-policies/
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