Linked Exchange Rate System
What Is a Linked Exchange Rate System?
A linked exchange rate system is a method of dealing with a country's currency that joins it to one more currency at a predetermined exchange rate. While linked to one currency, the managed currency can in any case float against different currencies.
How Does a Linked Exchange Rate System Work?
Countries lay out currency exchange rate policies with different countries, like Hong Kong and the U.S., which involve an agreement to tie, or peg, one currency's value to the next. This keeps the exchange rate at a stable level between the two countries. It likewise means that, paying little heed to different economic occasions occurring, the cost of things will continue as before between the two pegged currencies.
If the exchange rate starts to shift too much from the laid out, fixed ratio, currency is added to or taken out from circulation by a central bank to bring the ratio back into the acceptable reach. The currency being managed might be issued just when there are reserves in the linked currency to back it up.
Linked exchange rate systems have been beneficial to certain countries. The Hong Kong dollar has been linked to the U.S. dollar for over 30 years. During this time, Hong Kong has developed into an international financial center, and its assets in its banking system have developed by 13 times. Its gross domestic product additionally has duplicated almost 10 times.
Illustration of a Linked Exchange Rate System
Africa's biggest economy lives in Nigeria, and its currency was linked to the U.S. dollar for a long time. By 2016 however, the country's economy had been sliding into a recession and the country pursued a choice to unpeg its currency, the naira, from the U.S. dollar. Nigeria's central bank eliminated the peg trying to cure constant foreign currency deficiencies that stood in the method of Nigeria's growth as an important part of Africa's economy.
The naira turned into a "managed float" currency, implying that its currency value vacillates over the long run, and its central bank endeavors to influence the currency's value relative to that of other countries' currencies through buying and selling different currencies to keep inside a certain exchange-rate range.
Limitation of the Linked Exchange Rate System
A country's central bank loses a portion of its control over interest rates, inflation and different issues of fundamental monetary policy with a linked currency. For instance, in the event that the pegged country is getting along admirably, one more country with a linked currency can't involve currency depreciation to its advantage in trading with foreign partners and can't carry out monetary policy to adjust to shifts in the domestic economy.
Frequently countries that utilization a linked exchange rate system indicate a trading range around the chose exchange rate. This band around the fixed rate, which is many times plus or minus 1%, adds a flexibility to the system. A few countries have likewise employed a "crawling peg" system. This system allows for an adjustment of the fixed rate to make up for differences in certain economic factors between the managed currency country and the country of the linked currency.
Features
- Linked currencies experience less change, which makes it more straightforward to anticipate their developments however harder for people to profit during currency trading.
- The advantage of a linked exchange rate system is that it balances out the currency and keeps inflation low.
- Pegging currencies to one another can have trading and effects on a country's GDP more unsurprising.
