The most countries that have sustained a peg for at least five years are very small open economies ( Caribbean countries, Barbados, Antigua, Bahrain), often highly specialized in tourism or fiscal havens. Explain why fixed exchange rates are particularly advantageous for these countries.
Lilian Mboya Thank you for your contribution.
However, you provide examples based on the UK but I am talking about small economies.
Likely the best answer is predictability in the value of their currency. Being small and open may make these countries particularly susceptible to wild swings in valuation based on international exchange activities. This is bad for businesses in these countries which provide goods and services to international markets. Pegging provides security for these businesses and the foreign companies that they trade with.
Jesse A Matheson Professor, great thanks for contribution. What would be your response if I ask you to explain the above scenario using the currency of any one of the above listed country?
Great Thanks
Hi Muhammad Ramzan, unfortunantly I do not know too much about those speicific countries. However, tourism may be important for them. An unexpected appreciation currency would be very bad for tourism; pegging will ensure that is less likely to happen.
I think it is difficult for small countries to maintain a flexible exchange regime as the market forces are not there to determine a stable market equilibrium exchange rate.Therefore it is not coincidence that as a rule small countries opt out for a fixed exchange rater. In this sense small countries enjoy stability as both businesses and individuals such as tourists and citizens eagerly hold the currency. However the governments of small countries must be very careful to adopt the correct monetary and fiscal policies that stops currency speculators from targeting a currency and begin speculative attacks to gain large profits against a country whose currency is considered n misaligned. This can cause an exchange rate crisis that soon can move to the real economy with grave negative effects. Particularly small countries must maintain price stability. George K Zestos
Fixed exchange rates provide a basis for companies to plan ahead. In such a case, the Central bank need to have the reserves to peg the exchange rate at a comfortable level. Stability is important for business planning compared to wide volatility. Even the futures/options markets are not protective of such volatility.
Chung Tin Fah Professor, Thank you very much for your contribution.