Why might a country peg its currency to another?

A country might peg its currency to another to stabilise its exchange rate and control inflation.

Pegging a currency to another is a policy decision taken by a country's central bank. This is often done to stabilise the exchange rate, which can help to reduce the risk of exchange rate fluctuations. This is particularly beneficial for countries that are heavily involved in international trade, as it can make their exports and imports more predictable and stable.

Moreover, pegging a currency can also be a tool to control inflation. By tying the value of the currency to a more stable and low-inflation currency, a country can import some of that stability and keep inflation in check. This is often the case for developing countries, which may struggle with high inflation rates.

Another reason for pegging a currency is to attract foreign investment. A stable exchange rate can make a country more attractive to foreign investors, as it reduces the risk of currency depreciation. This can lead to increased capital inflows, which can boost economic growth.

However, it's important to note that pegging a currency also has its downsides. It can limit a country's monetary policy flexibility, as it needs to maintain the peg. This can be particularly challenging during economic downturns, when a country might want to lower its interest rates to stimulate the economy. Furthermore, maintaining a peg can be costly, as it often requires large foreign exchange reserves.

In conclusion, while pegging a currency can bring stability and control inflation, it also comes with challenges and trade-offs. Therefore, whether a country should peg its currency or not depends on its specific economic circumstances and policy objectives.