Exchange Rate Targeting

Exchange rate targeting involves setting a fixed level or band of values for the exchange rate against a major currency, with the central bank supporting the target by buying and selling the national currency in foreign exchange markets.

When the central bank or monetary authority chooses to target an exchange rate, interest rates and conditions in the domesticeconomy must adapt to accommodate this target and domestic interest rates and money supply can become more volatile.

The monetary authority’s commitment to and ability to support the exchange rate target must be credible for exchange rate targeting to be successful.

Many currencies are pegged to other currencies, most notably the US dollar.

Other currencies operate under a “managed exchange rate policy,” where they are allowed to fluctuate within a range that is maintained by a monetary authority via market intervention.