Analyzing a Persistent Interest Rate Differential
Imagine a country with a fixed exchange rate policy. Despite the central bank making no changes to its official policy rate, it observes that market interest rates on its government bonds have risen to be 5 percentage points higher than the rates in the country to which its currency is pegged. Analyze the underlying economic forces that could cause this interest rate differential to emerge and persist, and explain why the central bank's ability to close this gap is limited while it maintains the fixed exchange rate.
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Analyzing a Persistent Interest Rate Differential
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