A currency peg, also known as a fixed exchange rate, is when a government maintains its currency’s exchange rate at a fixed rate relative to a foreign currency, a basket of currencies, or another commodity. This method is often used to ensure the stability of the exchange rate between countries that frequently engage in trade, such as the arrangement between Hong Kong and the United States. A currency peg, also known as a fixed exchange rate, is a policy in which a country’s government or central bank sets and maintains its currency’s exchange rate at a fixed value relative to another currency or a basket of currencies.

The main advantage of a currency peg is that it provides stability and predictability in international trade and investment, which can increase investor confidence. However, a disadvantage is the loss of flexibility in monetary policy. Countries with a currency peg cannot adjust their interest rates independently to respond to domestic economic changes.

This can become problematic during periods of recession, as the country with the peg will be reliant on fiscal policy as their monetary policy tools will be preoccupied with maintaining the pegged currency.