A soft peg describes the type of exchange rate regime applied to a currency to keep its value stable against a reserve currency or a basket of currencies. Currencies with a soft peg are half way between those with a fixed or hard pegged exchange rate and those with a floating exchange rate. The main difference between soft and hard pegged currencies is that the soft peg systems provide a limited degree of monetary policy flexibility to allow governments and central banks to deal with economic shocks.
Practical examples of soft pegs
A soft peg can be applied to the reserve currency within a narrow (e.g. 1%) or a wide (e.g. -25-25%) range and can sometimes be modified over time, usually in relation to variations in international inflation rates.
Soft peg currencies include the Chinese yuan, an interesting soft peg currency as it is softly pegged to the U.S. dollar while also being a reserve currency, the Venezuelan bolivar and the Hong Kong dollar (which are both pegged to the U.S. dollar).
Any kind of peg can be vulnerable to financial crises – which can result in a significant devaluation or even lead institutions to abandon the peg. Notorious examples of events like these are the Argentinian crisis of 2001 of the Swiss National Bank’s decision to abandon the euro peg in 2015.