Exchange Rate Management: Fixed Parity with Crawling Bands

If a nation issues a currency that is guaranteed to be redeemable for another currency at a specific exchange rate (one that will not change over time or in certain circumstances), then it has a fixed parity exchange rate system.

In practice, a fixed parity exchange rate system involves keeping the exchange rate in a very tight band—perhaps always within one percent of an announced exchange rate. Under a __fixed parity exchange rate with a crawling band__, however, the currency is allowed to fluctuate more broadly around an announced rate. Which of the following best captures the idea that a currency can fluctuate around an announced exchange rate?

Correct! In this case, a currency may fluctuate by several percentage points around an announced target this month and over time that allowed range (i.e., band) can grow (i.e., crawl).

Incorrect. The flexible band typically refers to a band that is broadened. If a monetary authority sought to move toward a fixed parity regime, it is more likely to simply announce that target exchange rate.

Incorrect. This exchange rate regime is more commonly referred to as a crawling peg and can be useful to keep a nation’s exports competitive when that nation is experiencing high inflation.

A monetary authority that may be moving away from a fixed rate regime and toward a free floating currency may choose to adopt a crawling band. With a crawling band, a currency may be allowed to fluctuate in only small amounts in the first year—perhaps always staying within 1% of a published exchange rate. Over time, however, greater and greater fluctuation is permitted—perhaps a currency can wobble around a published rate by several percentage points. In which scenario below is a monetary authority using a fixed parity system with a crawling band?

Incorrect. In this case, the currency is being allowed to slowly depreciate. That would more accurately be described as a crawling peg.

Incorrect. This more accurately represents a fixed exchange rate. In this case, the band around the exchange rate is quite "tight," unable to fluctuate more than 1%.

Correct! It is the idea that the currency can "wobble" around an announced fix rate by an increasing amount that gives the band its “crawl.” This type of system can allow them to gradually "release" the currency from its pegged rate and foster confidence in the currency and the new exchange rate system.

An exchange rate system involving fixed parity with a crawling band is not ideal for all economies. Which of the following might best describe a nation that is considering the adoption of this type of exchange rate regime?

Correct! A nation that believes it may face difficulties moving directly to a free floating exchange rate regime may first explore crawling pegs or crawling bands.

Incorrect. Given high inflation, this nation is probably concerned that its exports are increasingly expensive to foreign consumers. To protect exporters, that nation would likely be more attracted to a system that involved fixed parity with a crawling peg.

Incorrect. If this monetary authority believed that the currency was overvalued, it could adjust the official exchange rate.

In summary: [[summary]]

For a nation seeking to move to a more flexible currency regime, a crawling band may be attractive. Under this system, a monetary authority may allow that band to gradually widen over time. Once the band reaches sufficiently wide range, the monetary authority may be comfortable relaxing it altogether thereby moving to a free floating currency. As such, a fixed parity with a crawling band exchange rate system might be looked at as an intermediate step when transitioning from a fixed to a floating exchange rate system.

A monetary authority allows an exchange rate to fluctuate several percentage points on either side of an announced fixed exchange rate

A monetary authority allows an exchange rate to fluctuate less, perhaps moving closer and closer to an announced fixed exchange rate

A monetary authority allows an exchange rate to depreciate consistently over time

A monetary authority guarantees that the domestic currency is redeemable for US dollars at a rate of eight to one today but also states that the domestic currency would be allowed to depreciate by 3% per year

A monetary authority guarantees to hold its currency with 1% of an eight to one exchange rate with the US dollar

A monetary authority guarantees to hold its currency with 1% of an eight to one exchange rate with the U.S. dollar but plans to allow that band to increase to 5% within one month

A nation that wants to abandon a fixed parity exchange rate regime

A nation that is experiencing high levels of inflation

A nation with a fixed parity currency that is considered highly overvalued

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