Pegged or Free Floating Exchange Rates
What is the difference between a pegged exchange rate and a free floating exchange rate ?
A free floating currency exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly as quoted on financial markets, mainly by banks, around the world.
A pegged currency maintains a fixed currency exchange rate against other currencies. This rate is often determined by the government or central bank of that currency.
Countries that have immature, potentially unstable economies usually use the pegged system. Developing nations can use this system to prevent out-of control-inflation. The disadvantage of the system is that it can backfire if the value of the currency does not really show the true value of the currecny. A black market may spring up, where the currency will be traded at its market value, disregarding the government’s peg.