How does pegged exchange rate work

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I understand the exchange rate is dependent on supply and demand of the currency. Some currency like UAE Dirham has been pegged to the dollar for decades. How does that work?

In: Economics

4 Answers

Anonymous 0 Comments

To peg the exchange rate, you simply have to have a very wealthy organisation (like a government) buy/hold the currency whenever its price gets too low, and sell/spend the currency whenever its price gets too high.

That way, the supply and the demand are always balanced out.

It takes a *lot* of money to do this and the more the exchange rate wants to stray the more money it costs, but it does result in a greater ease of doing business which can therefore improve the economy of the nation – theoretically increasing tax revenue enough to pay for the cost of pegging the currency.

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