The Crawling Peg, Keeping Up with Changes

by Investing School on June 27, 2011

The term crawling peg is a system which adjusts the exchange rate at which a currency is traded in order to make up for market factors such as inflation. Unlike a fixed rate, the crawling peg provides a gradual shift in the currency’s par value instead of having a currency suddenly, and significantly drops in value. A crawling peg might also be referred to as a floating exchange rate. The opposite condition is a fixed peg rate or pegging.

In order to institute an appropriate crawling peg, central banks employ a formula which initiates a change when certain pieces fall into place. For example, a country may need to adjust for excessive inflation. Other banks prefer not to use a preset equation; rather, they change their exchange rates as often as necessary to prevent, or at least discourage, speculation.

A classic example occurred in the 1990s in Mexico. Mexico had fixed its currency, the peso, to the U.S. dollar. After the currency was fixed, Mexico experienced dramatic inflation, when compared to that in the U.S., leading to a situation where the peso was likely to be significantly devalued.

Since a rapid devaluation would cause financial instability, Mexico implemented a crawling peg exchange rate adjustment plan and the peso moved slowly towards a more realistic rate of exchange.

The truth is that no currency is truly fixed or floating. Market pressures, rates of inflation, black market influences and other factors come into play when determining the exchange rate of any currency when compared with another.

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