In a majority of cases nations maintain a regime of fixed currency for the purposes of controlling inflation. Because government traditions in markets which are emerging tend to be weak, political incentives for strong inflating money supply and the monetary authorities independence is limited, or non-existent, inflation can become uncontrollable and rampant by the use of traditional method of interest rates being increased. Learn this and more at cfd trading South Africa.
With the public expecting prices to go up, and pressing for higher wages in return, majority of the firms raise prices and feedback loop based on the psychological attitude of the market participants can last for an indefinite time, doing great harm to the economic health of the nation.
In most cases, the government that created the phase of inflationary is unwilling in solving the problem and as it gets to be replaced at the elections, the incoming government gets handed the situation that demands serious solutions.
One of the serious solutions is pegging the currency. When it is instituted, the government makes an irreversible, clear commitment in keeping any money supply growth beyond that of being able to control the central bank limited by the real inflow of the foreign currency into the nation via the external activities.
It denotes that, the printing presses of the pegging nation will be utilized only as often as that of the nation that is controlling which is normally a country in the developed world that has a well-established and credible policy.
There are times when governments and central banks introduce pegs in the preparation of a monetary union. Because the currency of the pegging nation is likely to be abolished in time, it is important that you allow the public in getting used to the new unit of the value through maintaining a peg as while the new institutions and regulations are being constructed. The present Danish peg is one of the examples of such a regime.
It is also possible that the peg can be maintained for reasons which are political, which tends to limit it to economic justifications. For the Gulf Arab states, and their much criticized and publicized dollar pegs, the major advantage is the military and political support of the USA.
The nations currently have a favorable current account position in building a forex reserve that is considerable and because they aren’t exporters, they don’t require maintaining any low exchange rate in helping with their trade income.
Although it is necessary to have a dollar peg for ensuring that the inflation is controlled at times, there are times when the monetary policy of the US get highly inflationary, getting to negate such a benefit. But with the Gulf states mainly looking out for political benefit for maintaining their pegs, the issues is ignored by them in most cases
Pegs can as well be introduced on a temporal basis when responding to a currency crisis without any relation to inflation. In majority of cases, such regimes get removed in time.