In plain English
What Currency peg means
To maintain a peg, the monetary authority normally stands ready to buy or sell foreign currency and may adjust domestic interest rates or use other measures. The anchor can be a single currency, such as the U.S. dollar, or a basket designed to reflect trade partners. Some pegs are very rigid, while crawling pegs are adjusted gradually under stated or discretionary rules.
Why it matters
A peg can reduce short-term exchange-rate uncertainty against the anchor, which may simplify pricing, trade, and debt servicing in that currency. In return, it can limit independent monetary policy and require adequate reserves and credible policy. If market pressure becomes too large, an authority may devalue, widen the band, or abandon the arrangement; none of those outcomes is risk-free.
Example
Assume a central bank sets a peg of 7.00 local currency units per U.S. dollar. If market demand would otherwise push the rate to 7.20, the authority may sell U.S. dollar reserves and buy local currency to support the 7.00 rate. This simplified illustration ignores transaction costs, interest-rate policy, and possible controls on capital flows.
Quick answers
Common questions
What is an anchor currency?+
An anchor currency is the currency, or sometimes currency basket, used as the reference for a peg. The domestic authority manages its exchange rate relative to that reference.
Does a currency peg eliminate exchange-rate risk?+
No. It may reduce day-to-day variation against the anchor, but the peg can be adjusted or abandoned. It also does not eliminate exchange-rate movements against currencies outside the peg.
Sources