Flexible peg is an exchange rate system in which the central bank pegged the exchange rate of the domestic currency against foreign currencies in a short period. Pegging can take place through intervention or market mechanisms.
In this system, the central bank pegs the exchange rate, so it does not fluctuate from day to day. However, governments regularly review their pegs and make slight adjustments in response to changes in market strength or fundamentals. Yet, the central bank does not commit to maintaining the exchange rate at a certain level.
Advantages of flexible Peg
This system reduces exchange rate instability in the short term because of less fluctuation.
Avoidance of exchange rate volatility in the short term is essential for the economy. Volatility carries costs, i.e., hedging costs for debtors and creditors. Thus, low volatility allows low hedging costs, thereby reducing losses in economic decision making.
That contrasts with the full floating exchange rate, where volatility in short-term exchange rates is unavoidable.
Furthermore, although the pegged exchange rate cannot be used as a nominal anchor, the flexibility of this system enables the implementation of an independent monetary policy.
Next, the pegging exchange rate is at cost. It requires substantial foreign exchange reserves, which not all economies have.