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What is Currency Pegging?
Currency pegging simply means that a country fixes
the exchange rate of its currency to the currency of another
country.
In the case of the Eastern Caribbean Currency Union, the
EC dollar has been fixed to the US dollar at a rate of EC$2.70
to US$1.00 since 1976. Prior to this the EC currency was fixed
to the pound sterling at an exchange rate of EC$4.80 to £1.00.
However, following the sterling’s depreciation (decline
in value) in the 1970’s, the decision was made to shift
the peg to the US dollar.
Any decision to alter the peg of the EC currency rests with
the Monetary Council, the highest decision making body of
the Eastern Caribbean Central Bank (ECCB).
Implications of the Peg
The pegging of the EC currency to the US currency implies
that when the value of the US dollar fluctuates relative to
other currencies, the EC dollar undergoes a similar fluctuation
in value relative to other currencies.
Let us take for example the case of the pound sterling. During
the first and second weeks of February 2004, reports indicated
that the pound sterling appreciated (rose in value) against
the US dollar. The actual rate moved from US$ 1.8477 to £1.00
on February 6th 2004 to US$ 1.8852 to £1.00 on February
13th 2004. Similarly the EC dollar moved from a rate of EC$
4.9888 to £1.00 to a rate of EC$ 5.0900 to £1.00
over the same period.
In this scenario, where the pound sterling rises in value
against the US dollar and by extension against the EC dollar,
it means that citizens of the Eastern Caribbean Currency Union
(ECCU) would benefit if they were in receipt of pounds and
were able to convert them to EC dollars at the higher exchange
rate. Additionally, receipts from ECCU exports denominated
in pound sterling, would upon conversion into EC dollars,
be larger. On the flip side however, persons who have to convert
EC dollars to pounds to pay, for example, college tuition
in the UK, or ECCU member governments who have to repay loans
denominated in pound sterling would be at a disadvantage.
This is because it would require more EC dollars to purchase
the required amount of pound sterling.
Rationale For The Peg
In the case of the ECCU, the rationale for pegging
the EC currency to the US currency is the fact that most of
the external trade and financial (capital) flows are carried
out with the United States. When the region engages in US$
denominated transactions, whether trade or credit (loans),
the peg eliminates uncertainty in the prices of goods and
services and the value of debts due to fluctuations in the
value of the currency. Simply put, the US dollar acts as an
anchor for the EC dollar.
Moreover, by providing certainty as to the value of the EC
dollar relative to the US dollar, the pegging of the EC currency
allows foreigners to have confidence in the currency of the
region. Confidence in the EC dollar, has also been a significant
deterrent to capital flight and to a preference for the holding
of foreign currency over the EC currency.
Other Exchange Rate Regimes
The opposite of a fixed exchange rate regime is a
flexible exchange rate regime. Such flexibility can range
from a “free floating currency” regime where the
value of the currency fluctuates according to market forces
to a “managed float” that permits the value of
the currency to move within a set range.
In a free-floating currency regime, the prices of imported
goods as well as local goods requiring foreign inputs will
most likely fluctuate in tandem with, but in the opposite
direction to, the changes in the value of the local currency.
In such a scenario, the consumer will have to continuously
reassess the amount of goods and services that his wages can
provide.
Conclusion
The EC dollar fixed exchange regime, with the EC
currency pegged to the US dollar at a rate of EC$2.70 to US$1.00,
has served the region well. The region has historically enjoyed
a relatively low rate of inflation, incremental improvements
in the standards of living for its people and economic stability.
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