Principles of Macroeconomics / Unit 13 MAC 1221 worked example, 60 to 90 seconds
Classifying a Regime
The idea
From a description of what a government does, name the regime and state the trade it has accepted. Ask two questions: does the rate move with the market, and does the country still run its own monetary policy? The answers place any arrangement on the spectrum.
In practice
A government that does nothing and lets the rate swing is floating, and it keeps monetary policy for domestic use. A central bank that lets the rate move but sells its currency when it climbs too fast is running a soft peg. A country that fixes its rate to another currency by law and holds foreign assets to back every unit it issues has a hard peg through a currency board, and has given up most of its monetary independence; one economy ran such a board through the nineteen nineties and abandoned it in 2002 when it needed a policy the board forbade. A country that adopts another country's currency, or joins a shared one, has a merged currency and has no monetary policy of its own at all.
Where people slip
No regime is best, and the anchor says so. Each trades predictability against independence, and the price only becomes visible when a country needs the policy it gave up. So the last question to ask of any peg is not whether it is holding, but what happens when it stops.
Your place on the trail
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Unlocks
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