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Chapter 19: Q.15 (page 528)

Why did the exchange-rate peg lead to difficulties for the countries in the ERM after the German reunification?

Short Answer

Expert verified

These situations also increased unemployment in these countries which finally led to the crisis in September 1992. So, the rationale for rate of exchange peg results in difficulties for the countries within the ERM after the German reunification is that the restricted control of the target countries' governments on the cash supply and rate.

Step by step solution

01

Concept Introduction

Pegging refers to the monetary policy or strategy that has targeting the worth or fixing the worth of the domestic currency to the foreign currency a bit like the gold standard. The changes within the value of the foreign currency will influence similar change within the targeted or domestic currency.

02

Explanation of Solution

After German reunification, inflationary pressure started arising in Germany that increased the speed of interest in Germany as in pegging, shocks to the anchor country will result in a corresponding change within the target country. So, the rise in rate occurred within the countries too, which was pegged with the Deutsche Mark. The increased rate of interest results in a decline within the demand which will cause decrease within the economic process of the countries in ERM.

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Most popular questions from this chapter

For each of the following, identify in which part of the balance-of-payments account the transaction is recorded (current account, capital account, or net change in international reserves) and whether it is a receipt or a payment.

a. A British subject’s purchase of a share of Johnson & Johnson stock

b. An American citizen’s purchase of an airline ticket from Air France

c. The Swiss government’s purchase of U.S. Treasury bills

d. A Japanese citizen’s purchase of California oranges

e. $50 million of foreign aid to Honduras

f. A loan from an American bank to Mexico

g. An American bank’s borrowing of euro dollars

If the Federal Reserve buys dollars in the foreign exchange market but does not sterilize the intervention, what will be the impact on international reserves, the money supply, and the exchange rate?

Under the gold standard, if Britain became more productive relative to the United States, what would happen to the money supply in the two countries? Why would the changes in the money supply help preserve a fixed exchange rate between the United States and Britain?

If a country’s par exchange rate was undervalued during the Bretton Woods fixed exchange rate regime, what kind of intervention would that country’s central bank be forced to undertake, and what effect would the intervention have on the country’s international reserves and money supply?

What is the exchange rate between dollars and Swiss francs if one dollar is convertible into 1/40 ounce of gold and one Swiss franc is convertible into 1/25 ounce of gold?
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