Fixed Exchange Rate

When a nation ties its currency exchange rate to another country’s currency or to the gold standard. This is also called a “pegged exchange rate.”

Fun fact: most fixed exchange rates are “pegged” to the U.S. dollar. In addition to being relatively stable, the U.S. dollar also holds the distinguished title of Most Popular Global Currency. This means that the dollar is accepted for payment in most parts of the world, even if that country has its own currency.

For example, if we decide to vacay in Costa Rica, we can pay for stuff using U.S. dollars, Costa Rican colòns, or a combo of both. The exchange rate of dollars to colòns is fixed, meaning that, on any given day, we know for sure exactly how many colòns equals one USD.

The yen and the euro are also part of the popular crowd when it comes to fixed exchange rates.

On the plus side, a fixed exchange rate can enhance a currency’s stability big-time. Investors are less wary of investing in certain countries when that country’s money is seen as stable. Why? They know there’s less of a chance of their investment going poof because the country’s currency became devalued to the point of being worthless.

Just like any intervening protective measure, though, fixed exchange rates also come with drawbacks. Since the rate is tied to something else, it can’t be easily adjusted during good economic times.