A fixed parity system is when a country binds the value of its currency with a single currency or a basket of major currencies. In maintaining the exchange rate in a narrow band, the central bank is ready to intervene in the exchange rate market using foreign currency reserves.
Monetary independence is relatively limited in this system. Because it fixes the exchange rate, its monetary policy is tied to foreign monetary policy.
The discipline and credibility of the central bank determine the success of this system. Foreign exchange reserves must be sufficient to make the central bank credible in intervening in the forex market. If it is not enough, then the domestic currency is vulnerable to speculative attacks and devaluation.
The difference between the currency board system and the fixed parity system
In the fixed parity system, monetary authorities can choose to adjust or ignore parity. There is no legislative commitment to maintaining the specified parity, as in the currency board system (CBS).
Furthermore, the level of foreign exchange reserves is discretionary and not related to the domestic monetary base. In a sense, changes in base money do not have to be followed by changes in foreign exchange reserves on an equal basis, as in CBS.
