What is Linked Exchange Rate System?

Linked exchange rate system is a currency exchange rate regulating system where exchange rate of one currency is linked to the exchange rate of other currency. This system was introduced in 1983 in Hong Kong after the Black Saturday crisis. Unlike fixed exchange rate system, linked exchange rate system do not involve government/central bank interfere other than setting the exchange rate.

In linked exchange rate system the exchange rate between two linked currencies are kept constant (or at a range). When ever there is a shift occurs, excess currency is quickly taken out or adequate currency is added to the economy to keep the balance. For keeping the relation the nation back up its currency with its foreign reserve. When ever a change in monetary base occurs, then the foreign reserve is also adjusted to meet the change.

For example Hong Kong follows a linked exchange rate system for its currency Hong Kong Dollar (HKD) with United States Dollar (USD) at 7.8 ($7.8 HKD = $1 USD); actually Hong Kong now allows its currency to float between an upper (7.85) and lower (7.75) limit. When market rate drops bellow 7.8, banks will buy USD spending HKD and if it rises above 7.8 then banks will buy HKD spending USD. Advantage of linked exchange rate is the low inflation, but the disadvantage is less adaptive economic policy.

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