Me14
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Report Thread starter 7 years ago
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Hey guys,

The Tutor2u Toolkit says, in order to maintain a currency peg, the central bank can:

"raise domestic policy interest rates: Increasing the interest rates will lift the expected return to short term flows of capital coming into the country's banking system. Other things being equal, an influx of "hot money" will cause an outward shift in the demand for the currency and an appreciation of the exchange rate - helping to maintain the currency peg"

...I don't understand how you can have a fixed exchange rate and use monetary policy?

And surely if its fixed then it means that the central bank can directly declare a new fix but can't revalue/devalue the currency through monetary policy?
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PaulKrugman
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You're getting confused. A fixed exchange rate does not mean you have fixed monetary policy. Even then, a fixed exchange rate doesn't mean they suddenly announce what the exchange rate will be and it says like that. Market forces will cause the exchange rate to deviate from what it was fixed to (the currency peg), but monetary policy as the toolkit suggests should be used to increase or decrease the exchange rate to bring it back to were the peg is at.

The BoE will HAVE to change interest rates if it wanted to pursue a specific currency peg.
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gr8wizard10
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The government can also manually try and control exchange rates by either selling their currency reserves (similar to China depreciating their own currency) or buying their own currency to manually increase demand.
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