Jordan’s currency, the Jordanian Dinar (JOD), is pegged to the USD. From 2007 to 2013 the rate fluctuated between 0.7053 and 0.7107 USD to JOD, and then since the beginning of 2014 it stayed unchanged at 1 Jordan dinar = 1.41USD.
In order to maintain a fixed currency, Jordan’s central bank will use policies to control demand and supply of the currency. As shown o the diagram, suppose that Jordan’s currency decreases in demand from D1 to D2, causing rate to decrease from 1.41USD=1 Dinar to 1. The government use either increase demand or decrease supply to make equilibrium point back at level of 1.41. The central bank can buy Dinar in the FOREX by selling foreign reserves, forcing up Dinar’s demand. The central bank can also increase interest rate, to attract financial capitals to invest in Jordan, thus making demand for A’s currency to increase. Or the central bank can decrease supply, such as impose policies to limit imports. If demand increased rather than decrease, the government as well can take opposite policies to maintain a pegged exchange rate.
Having a fixed exchange rate has some advantages. A pegged exchange rate brings stability and high degree of certainty over future exchange rate, and is able to attract firms, importers, exporters, and investors. This lets Jordan to gain investors’ confidence, and leads to positive effects on investment, and volume of trade. In addition, Dinar will be strengthened if pegged to the USD, as US dollar is the world’s most held reserve. Jordan can avoid inflation for instance, as it will share the strength of the pegged currency. Without that fixed exchange rate, the smaller country’s currency will slide and often make imports from the large economy become more expensive, and cause problems like imported inflation. Finally, another advantage is that Jordan can attract foreign funds with no risk of possible loss of exchange, as the rate between Jordan Dinar and US dollar will always be the same. Thus, Jordan doesn’t need to fear for currency speculation as exchange rates are fixed.
Before Jordan pegged the dinar to the dollar, capital flight and conversion of Dinars into foreign currencies often occurred, damaging Jordan’s domestic economy. But after the pegged system, funds were repatriated, and foreign and Arab deposits in Jordanian banks grew, as seen by the huge amounts of non-resident deposits in the Jordanian banking system. From these we can see the benefits of a pegged system and how it worked perfectly well with Jordan Dinar.
On the other hand, using a pegged currency may have some disadvantages as well. Fiscal policy and monetary are two crucial policies for the government to manage aggregate demand, but if they want to peg their currency, monetary policy will no longer be available to deal with domestic problems, since interest rates must be used to maintain the exchange rate. In the case of Jordan, it keeping its currency pegged to the US dollar means that a higher interest rate will be present, which is not ideal for a country that is struggling to grow. Maintaining a pegged currency also needs constant intervention by the central bank to fix the rate. Central bank also needs to hold large amounts of foreign currency reserves to be able to intervene with purchases of the domestic currency whenever necessary. This can be expensive to maintain and country must have enough foreign exchange reserves to manage its currency’s value.
When considering the methods used to maintain a fixed exchange rate, they also each have some drawbacks. As central banks use buying and selling of foreign reserves to maintain the exchange rate, there is a possibility where central bank eventually runs out of reserves of foreign exchange to sell. This demonstrates a limitation of this policy, as it has a constraint to an extent. When central bank increases interest rates to attract foreign investments to increase demand of the currency, this might cause recession in the economy as people are not willing to spend their income, they would prefer saving it instead. As increasing interest rate is a contractionary monetary policy, it would harm a developing economy that’s struggling to grow, and may cause economic slowdown and ultimately recession. In order to increase demand government can also borrow from abroad. But this raises a concern on. Government budget and its repayment costs burden the economy in the future. By controlling supply of domestic currency, government typically will choose to limit imports through trade protection measure and impose exchange controls. This leads to resource misallocation and risks of retaliation that can damage the country’s economy and political position.
Making an economic decision will have both costs and benefits, and some groups will benefit from an economic decision, while others could be hurt. Pegging the Dinar is in the interest of the country of Jordan as the benefits it Brough to Jordan outweighs the disadvantages. It achieved monetary stability, reinforced public confidence, attracted Arab and foreign investments, and has been a very successful policy even with some drawbacks, such as being unable to use monetary policies to stimulate/cool off economic activities..