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💵principles of macroeconomics review

key term - Adjustable Peg

Citation:

Definition

An adjustable peg is an exchange rate system where a country's currency is pegged to another currency or a basket of currencies, but the peg can be adjusted periodically to account for changes in economic conditions. This allows for some flexibility in the exchange rate while still maintaining a fixed or semi-fixed exchange rate policy.

5 Must Know Facts For Your Next Test

  1. Adjustable pegs allow countries to maintain some control over their exchange rate while still allowing for adjustments to account for economic changes.
  2. The peg is typically adjusted periodically, often in response to changes in a country's balance of payments or inflation rate.
  3. Adjustable pegs are a compromise between the rigidity of a fixed exchange rate and the volatility of a floating exchange rate.
  4. Devaluation is a common adjustment made to an adjustable peg, where the currency is intentionally set at a lower value relative to other currencies.
  5. Adjustable pegs can help countries maintain export competitiveness and stability, but they also come with the risk of speculative attacks and the need for periodic adjustments.

Review Questions

  • Explain how an adjustable peg exchange rate system differs from a fixed exchange rate system.
    • The key difference between an adjustable peg and a fixed exchange rate system is the flexibility to make periodic adjustments to the exchange rate. In a fixed exchange rate system, the currency is tied to another currency or a basket of currencies at a predetermined and unchanging rate. In contrast, an adjustable peg allows the exchange rate to be adjusted periodically, often in response to changes in economic conditions such as the balance of payments or inflation. This provides more flexibility than a pure fixed exchange rate, while still maintaining a degree of exchange rate stability.
  • Analyze the potential benefits and drawbacks of an adjustable peg exchange rate system.
    • The potential benefits of an adjustable peg system include: 1) Maintaining a degree of exchange rate stability to support trade and investment, 2) Allowing for periodic adjustments to account for changes in economic conditions and maintain export competitiveness, and 3) Providing more flexibility than a pure fixed exchange rate system. However, the drawbacks include: 1) The risk of speculative attacks on the currency if the adjustments are not seen as credible, 2) The need for periodic adjustments which can be disruptive, and 3) The potential for the exchange rate to become misaligned with underlying economic fundamentals if the adjustments are not made in a timely manner.
  • Evaluate the role of devaluation in an adjustable peg exchange rate system and its potential consequences.
    • Devaluation, or the intentional downward adjustment of the exchange rate, is a common tool used in an adjustable peg system. Devaluation can help improve a country's export competitiveness and correct imbalances in the balance of payments. However, it also carries risks, such as fueling domestic inflation, reducing the purchasing power of consumers, and potentially triggering retaliatory actions from trading partners. Policymakers must carefully weigh the potential benefits and drawbacks of devaluation within the context of the adjustable peg system and the country's broader economic goals. Frequent or excessive devaluations can also undermine the credibility of the exchange rate regime and lead to speculative attacks on the currency.