currency peg and managed float
Suppose a country wants the calm of a stable exchange rate but worries about the risks of locking it rigidly forever. It has two popular middle paths. The first is a currency peg: officially tying the value of its money to a stronger anchor — most often the US dollar — and pledging to keep it there. The second is a managed float: letting the rate move with the market most of the time, but stepping in to steer it when it drifts too far. Both are ways of having a hand on the steering wheel without fully fixing or fully freeing the rate.
A peg works by promise plus muscle. The central bank announces a target — say 'our currency will stay at 3.6 to the dollar' — and then defends it by buying or selling its own currency in the market. If the currency starts to weaken past the line, the bank sells dollars from its reserves and buys back its own money to prop the value up; if it strengthens too much, it does the reverse. The strictest version, a currency board, legally backs every unit of local money with a foreign currency, leaving almost no discretion. A managed float (sometimes bluntly called a 'dirty float') is looser: the rate mostly floats, but the central bank intervenes occasionally to smooth out wild swings or nudge the trend, without committing to any precise number.
These hybrids are popular because they try to capture the stability of a fix and some of the flexibility of a float — but they carry their own dangers. Defending a peg can drain a country's reserves fast, and if speculators sense the central bank is running low, they may attack the peg, betting it will break. A managed float invites the opposite criticism: trading partners may accuse a country of quietly holding its currency cheap to boost exports, the charge of 'currency manipulation.' In short, the middle ground is comfortable in calm times and treacherous in a storm.
Saudi Arabia pegs its riyal to the US dollar at a fixed rate, spending oil revenues to defend it, which gives oil exporters certainty about their dollar earnings — while China for years ran a managed float, letting the yuan move within limits the central bank quietly enforced.
A peg pins the rate by promise; a managed float just nudges it now and then.
A peg is only as strong as the reserves and resolve behind it: once markets believe the central bank will run out of ammunition, a self-fulfilling attack can force the peg to break, sometimes within days.