I am the worst with Econ stuff… How does pegging a domestic currency to a foreign rob the domestic central bank of being able to use monetary policy?
i live in a country which has its currency pegged to the USD…the UAE dirham basically the interest rates here sorta follow the interest rate cuts/increases as in the US…because our currency is pegged…if these fellas didn’t do that…there would be a huge differential every time the us cut interest rates…but the UAE sat still…
The govt of the pegged currecny cannot do much in terms of modifying its monetary policy and affecting currecny value as it is pegged
In a pegged currency regime, the Central Bank will still have work to do buying and selling currencies, but they won’t have any CHOICE about how much they need to buy or sell. Suppose I live in Chadistan and the currency is pegged so that 2 chaddies = 1 euro. All sorts of things in the real economy are going to be pushing the chaddy up and down based on supply and demand from firms in the economy. If the currency is pegged, and I’m the central banker, I have to basically buy or sell whatever it takes to keep the ratio around 2 chaddies/euro. This means that I can’t run a monetary policy that controls interest rates for businesses, making it easier to get credit in hard times and harder in boom times, because that might require different amounts of buying and selling than maintaining the peg. As a result, economies in pegged regimes tend to go through bigger booms and busts than unpegged regimes. This is why floating currencies are often thought of as “shock absorbers,” because not all of the adjustment to economic conditions needs to happen through interest rates.