Crawling peg is a monetary regime that allows the national currency exchange rate to fluctuate in a specific range (band). The central bank tries to keep the exchange rate from moving out of the band.
China, Vietnam, Nicaragua, and Botswana are some of the countries that have adopted this system. They choose this system to promote the stability of the balance of payments. And, sometimes, they adjust the exchange rate periodically to increase the country’s competitive position in the export market.
How crawling peg works
Monetary authority adopts crawling pegs to control currency movements, mainly when the threat of devaluation arises because of inflation or economic instability. The central bank intervenes by selling and buying currencies in a coordinated manner, allowing par values to remain in the band.
The crawling peg consists of two, namely the par value of the pegged currency and the targeted deviation. The central bank can revise both, for example, as market changes or economic conditions.
Types of crawling peg
Crawling peg can be active or passive. It is active when the central bank pre-announce the target band while passive when it is coincident.
In the active crawling peg, the central bank has announced a range of exchange rates for the coming weeks. The central bank commits to maintaining the exchange rate in this range through changes in small steps. The ultimate goal is to manipulate inflation expectations.
Under the passive crawling peg system, the exchange rate is often adjusted in line with the inflation rate. The aim is to prevent a decline in foreign currency reserves.
Advantages and disadvantages of crawling peg
Some countries adopt this exchange rate to avoid economic instability due to the fall in foreign exchange reserves as in the fixed exchange rate system. At the same time, it also minimizes exchange rate fluctuations, because it directs the exchange rate to remain within the band. Low fluctuation promotes overall economic stability.
Critics consider this system, not the ideal. Similar to fixed exchange rates, significant currency flows make central bank intervention sometimes less credible. The flow might force the central bank to intervene, which leads to a substantial cost (the erosion of foreign exchange reserves).
That situation ever happened in Thailand in 1997. Speculators’ attacks forced the country’s monetary authority to ran out of reserves to maintain its currency.
