A fixed exchange rate (also called a pegged exchange rate) is a system in which the government or central bank sets and maintains the exchange rate at an official level. They intervene in the foreign exchange market to keep it within a narrow band or at a specific target.

How it works:

• The government announces a par value (target rate) for its currency
• To defend the rate, the central bank buys or sells its foreign exchange reserves
• If the currency falls below the target, buy the domestic currency (reduce supply)
• If the currency rises above the target, sell the domestic currency (increase supply)

Key features:

• Stability: Reduces uncertainty for international trade and investment
• Discipline: Prevents governments from running excessive deficits (they must maintain reserves)
• Loss of monetary policy autonomy: The central bank cannot independently set interest rates

Examples: Many developing economies and former systems (Bretton Woods 1944–1971, ERM, Hong Kong dollar).