Fixed, Floating and Pegged Regimes

Countries choose among many exchange rate regimes, each with trade-offs. A free float, used by the United States, Japan and the euro area, lets markets set the rate and leaves monetary policy free for domestic goals. A hard peg, such as Hong Kong's currency board fixing its dollar to the US dollar since 1983, offers certainty for trade and investment but gives up independent monetary policy. In between are crawling pegs, bands and 'managed floats', in which central banks lean against sharp moves.

Economists summarize the core constraint as the 'impossible trinity': a country cannot simultaneously have a fixed exchange rate, free capital movement and independent monetary policy, so it must choose two. Small economies heavily dependent on one trading partner often prefer pegs, while larger economies tend to float. Pegs can collapse spectacularly when markets doubt them, as Britain discovered in 1992 and Thailand in 1997.