Fixed vs pegged exchange rate: What's the difference (if any)?

Question

I am told very firmly by an economist that a pegged exchange rate is NOT the same thing as a fixed exchange rate. So what, if any, is the difference between the two?

Addendum: Here's one webpage about the difference. I am looking for simple explanation of the difference and ideally also some good and simple contrasting examples.

Add2: Robert Mundell has a lengthy classification here, but it seems to me that his distinction is not one of kind, but merely one of degree.

Answer 1

As Jason Nichols says, these terms are often used interchangeably.

The general theme is that pretty much anything can be called a "peg" (except perhaps the case where two countries are literally using the same currency), while "fixed" tends to refer to institutional arrangements that are more automatic, where changes in the exchange rate are perceived to be less likely. "Peg" tends to be used when some entity (e.g. a central bank) is doing the "pegging"; the more active and less automatic the behavior of this entity is, the more likely that you'll call the arrangement a "peg".

To further explain the (inconsistent and informal) differences in usage that do seem to exist, I have to describe several different kinds of exchange rate regimes.

1. At one extreme, country A may use the same currency as country B. Relevant cases include the Euro Area and dollarized Western Hemisphere countries like Panama and Ecuador. In this case, we might say that A and B have a "fixed" exchange rate (at one to one), but we probably wouldn't say that their rate is "pegged". A similar but less certain case would be, for instance, the CFA Franc in Africa, which is in principle distinct from the Euro but has a fixed Euro conversion rate and is guaranteed by the government of a country using the Euro (France). This might be called "fixed" or "pegged".
2. A less extreme situation is a currency board, where country A has a different currency than country B but promises to always convert them at a certain rate, and has reserves denominated in country B's currency backing up every unit of its own currency so that (in principle) this promise can always be fulfilled. Examples include Argentina's defunct currency board (a good example of a case where this promise was ultimately not fulfilled in practice) and Hong Kong's current currency board. I've seen both "fixed" and "pegged" used to describe such arrangements; as mentioned above, my sense is that "peg" is more common as a descriptor when the arrangement is perceived as being less automatic, with its permanence less certain.
3. Still weaker is the situation where country A sets a certain exchange rate with country B but doesn't have a formal arrangement like a currency board to back it up. This is extremely common; one rare example among developed countries is Denmark, which pegs to the Euro. This is the last case among (1)-(3) that can still often be called a "fixed" rate or a "peg". The line between this and a currency board in (2) is often blurry, since in this case too central banks often maintain large foreign reserves, perhaps enough to back up every unit of their currency outstanding; but usually this case involves a less universal guarantee of convertibility.
4. Then there is a vast set of arrangements where the rate is not perceived as being truly fixed for the indefinite future, but instead is allowed to fluctuate within a moderate or large band, or is subject to a "crawling" peg that is adjusted by the central bank, or is pegged to a possibly malleable basket of currencies, etc. These arrangements are usually called "pegs" rather than "fixed", because (after all) they aren't that fixed! A conspicuous modern example is China.
5. There are even looser arrangements where a central bank floats the currency but pays some attention to exchange rates and wants to avoid fluctuations that are too large (rather than exclusively hewing to some domestic objective like an inflation target), using both the tools of domestic monetary policy (interest rates) and intervention in foreign exchange markets to keep exchange rates in line. This is usually described as a "managed" float, "dirty" float, or something similar; it would rarely be described as a peg, but sometimes the line between (4) and (5) can be blurry.
6. Then at the extreme other end, we have countries that float their currencies and do not routinely intervene in foreign exchange markets. These arrangements would never be called either "fixed" or "pegged".

To sum up, my overall impression is that it's pretty vague, but that among 1 to 6 above, you're more likely to call something earlier in the list "fixed", something more in the middle of the list a "peg", and something later in the list a "float". But I am not aware of any formal, clearly specified distinction between terms as general as "fixed" and "peg". When exchange rates are classified, as in the IMF's annual report on the topic, this is usually done in a much more specific and descriptive way.

Answer 2

FIXED Monetary base money supply is adjusted automatically based on market exchange signals (central banks with a hard price rule) OR a currency board arrangement where there is a 1:1 ratio of foreign currency or bonds denominated in that foreign currency and the currency boards monetary base in circulation.

So, say Bulgaria -- which as a currency board -- has defined 2 levs to be equal to one euro and. A 2:1 exchange rate. So, if there are 20 billion levs in circulation then there must be 10 billion euros on deposit at the ECB in the Bulgarian currency board's name or 10 billion in actual euro cash notes in its vaults OR 10 billion in highest quality euro denominated bonds OR (and 99.999% the case) combinations of all of these.

In other words, the Bulgarians have a national currency -- the lev -- that is really tokens for euros and euro denominated assets held by the currency board. The currency board is legally obligated to exchange one form of the currency for the other and vice-versa. And since it has 100% reserves, nobody tries to challenge this exchange rate in the speculation markets.

In my opinion, for a modern economy it is just actually an extra layer of administration so someone can float the fixed currency and make money just like our banks float our check clearing times to make money when we pay our bills. This layer of unnecessary complexity can be easily removed by simply adopting the desired currency (in Bulgaria's case -- the euro) for direct use in question. Maybe an exception can be made for hard cash notes as they make up less than 3% of totally currency outstanding in most first world nations so you can have bills with pretty pictures of national figures native to your own land and all that. Better yet: Just let the chartered banks in your nation in this case print their own cash notes under certain guidelines instead.

But, Bulgaria doesn't need a currency board with 100% reserves to maintain a credible price parity if it wants to keep the lev. It can do so via a normal national bank instead that has a hard price rule fixed rate instead. In this case, the bank monitors the natural exchange activity of the two currencies to immediately detect any deviation of fixed rule price. If the price of the national currency goes up relative to the foreign currency, then that is a signal for the central bank to buy assets (debt) while releasing new national currency into circulation to pay for those assets. It does this until the price in the national currency drops back to where it should be. If it sees the opposite activity, it sells assets and removes currency it got from the sale of those assets from circulation until the price goes back up.

The main reason why nations adopt currency boards is because they so thoroughly trashed their non-currency board money supply in the past that nobody trusts them to manage it well again via that process. Think of the individual equivalent where someone without credit or good credit goes to a bank and forks over $500 for a secured credit card with a $500 limit. That secured credit card is like your own personal 'currency board' arrangement with the bank.

Note, these days no actual reserves in the foreign currency fixed is involved -- the only thing being adjusted is the national currency supply, which the central bank has complete control over. It is possible to operate this way with 0% foreign currency reserves, actually. This is how the gold standard systems worked as invented by the Bank of England in the 19th century and adopted by other central banks. Only they monitored actual cash to gold/gold for cash redemptions at their banks instead of globally instantaneous, traded internet forex pricing that they didn't have back then. They had gold reserves back then to, but they were 40% or lower depending on the nation's central bank.

BTW, whenever someone -- even someone with a Ph.D in Economics -- says that it is 'impossible' to return to a gold standard, they are only admitting their gross ignorance of the central banking version of this process by doing so. It is not only easily possible but would provide a lot more price stability as a result. That is because gold isn't used as money rather the currency is instead and its supply under this system is ALWAYS just right as far as demand is concerned. We did quite well under it in the '50s and '60s, if you recall.

PEGGED: Whereas 'pegged' currencies can range to being similar to the 'central bank with automatic currency supply adjustment example above' to much looser and less regulated options. The central bank wants to avoid declaring a hard price rule policy so it can fiddle with interest rates or do Keynesian witchcraft with the money supply or wants to outright lie about serious of its commitment to keeping currency parity either at the get go or later on (Argentina, Nixon closing the Gold Window, etc.). This is why speculators attack such currencies and why George Soros made a lot of money doing so. China is presently having difficulties and has adjusted its 'peg' to the US dollar as a result, as well. Almost all loose peg arrangements ultimately fail.