Historically, currency pegs have been used for various reasons. They may have been a way to stabilize the value of the dollar or other currencies, or to ensure that the value of the currencies will be maintained at certain levels. However, today, they have become a major concern, especially with the rising inflation rate in the United States.
Dollar pegs
Despite the recent tumbling of oil prices, Gulf Cooperation Council (GCC) countries have maintained their dollar pegs. GCC countries earn and spend in dollars. The United States is the region’s biggest trading partner and accounts for about one-third of its imports.
The oil-exporting GCC countries have been running currency pegs for decades. While the currency peg makes sense from an economic perspective, it may be a bad idea from a macroeconomic standpoint. A break in the peg may erode the real value of the local savings and reduce purchasing power. A break can also prompt capital outflows and increase the risk of inflation.
In the late 1990s, the strength of the dollar strained the non-oil sector. However, since oil-producing countries don’t need weaker currencies, a break in the peg is unlikely to have much impact on their economies.
Crawling pegs
Using a crawling currency peg system for exchange rate management is a good idea because it helps reduce the risk of exchange rate volatility, which is associated with a weakening currency. Crawling pegs can also help increase the competitiveness of an export market and help ensure the stability of a country’s balance of payments.
A crawling peg is a system used by central banks to manage the exchange rate of the country’s currency. This is done by coordinating the buying and selling of the currency in order to keep the par value in a band. This band may be either symmetric or asymmetric around the crawling central parity.
Crawling currency pegs are useful to control currency movements, which are a major cause of economic upheaval. The band or peg may be subject to revisions as market conditions change. The crawling peg can also be used to control the inflationary expectations of the economy.
The Bretton Woods system
During World War II, a group of 44 allied nations met in Bretton Woods, New Hampshire to find a solution to the currency exchange problems. The idea was to create a new international monetary system that would be flexible enough to encourage world trade but also stable enough to avoid mutually destructive devaluation.
The system was based on a series of rules and required each country to maintain a currency peg to the U.S. dollar. Normally, exchange rates were fixed, but under certain circumstances, they could be adjusted in a step-wise fashion. The US was the international reserve currency and was the first currency to be included in the system.
In the post-war period, fixed exchange rates allowed the US to serve as a central reserve currency and help to minimize the volatility of international currency exchange rates. However, when the US began inflating the economy, the international monetary system began to unravel.
Optimum currency areas
Optimum currency areas, or OCAs, refer to a monetary system that maximizes the economic efficiency of a group of countries. They can be defined as a geographical region, a monetary union, or some combination of the two. These areas are determined by factors such as the synchronicity of the business cycle, trade openness, and labor mobility.
Optimum currency areas are not an exact science. Several studies have been conducted on this topic. Some have focused on the economics of OCAs, while others have looked at the institutions that are necessary for such a union to operate.
There are a number of advantages to having a common currency. These include greater transparency, reduced transaction costs, and easier price comparison. Having a common currency also reduces the risk associated with fluctuations in currency values, which is a good thing for all involved. The downside is a loss of flexibility and independence.
The role of the IMF and ECB in the Greek currency crisis
Among the most controversial decisions of the European Central Bank (ECB) is its decision not to write down Greek government debt. Its refusal carries disturbing implications for the Eurozone and the central bank’s independence. It could be argued that avoiding a global crisis is the primary mission of the central bank. But it is also a tragic mistake.
Initially, the Greek government’s three-year bailout plan was supported by the IMF, which provided a three-year EUR110 billion loan with a 5.5% interest rate. The loan was conditional upon the implementation of tough austerity measures. These included tax increases, wage cuts, and reduced pensions. This was an ambitious program by international comparisons.
However, a new anti-austerity government led by Alexis Tsipras of the Syriza party came into power early this year. It demanded more debt relief and a rollback of the previous reforms.
