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Chapter 22: Problem 8

A country whose currency is the primary reserve currency can likely borrow at lower interest rates than it could if its currency were not the primary reserve currency. Do you agree or disagree? Explain.

Short Answer

Expert verified
Agree. Countries whose currency is the primary reserve currency can likely borrow at lower interest rates due to the high demand for their currency and the global economic confidence in their stability.

Step by step solution

01

Understand the Concept of Reserve Currency

A reserve currency is a foreign currency that central banks and major financial institutions hold as a means to pay off international debt obligations, or to influence their domestic exchange rate. A large amount of a certain currency being held as reserve currency often signifies global confidence in that currency and its issuing economy.
02

Analyze the Effects of Being a Primary Reserve Currency

Countries with currencies that are the primary reserve currency often experience 'exorbitant privilege'. This means, they can borrow money at a lower interest rate, as there is a high global demand for their currency. Also, these countries do not face a 'balance of payment' constraint and can run current account deficits persistently.
03

Agree or Disagree

Given the above analysis, one could argue in agreement that a country whose currency is the primary reserve currency can likely borrow at lower interest rates than it could if its currency were not the primary reserve currency. This is because of the high demand for that currency and the trust and confidence in its economic stability.

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Most popular questions from this chapter

Suppose the United States and Japan have a flexible exchange rate system. Explain whether each of the following events will lead to an appreciation or depreciation of the U.S. dollar and Japanese yen: a. U.S. real interest rates rise above Japanese real interest rates. b. The Japanese inflation rate rises relative to the U.S. inflation rate. c. An increase in U.S. income combines with no change in Japanese income.

Explain the details of the purchasing power parity (PPP) theory.

Country 1 produces good \(X,\) and country 2 produces good Y. People in both countries begin to demand more of good \(\mathrm{X}\) and less of good \(\mathrm{Y}\). Assume that there is no labor mobility between the two countries and that a flexible exchange rate system exists. What will happen to the unemployment rate in country \(2 ?\) Explain.

The lower the dollar price of a peso, the higher is the quantity demanded of pesos and the lower is the quantity supplied of pesos. Do you agree or disagree? Explain.

Give an example of how a change in the exchange rate alters the relative price of domestic goods in terms of foreign goods.
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