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Policy Dilemma for High-Inflation Economies: Fix the Exchange Rate or Abandon the Currency?
Argentine Peso-US Dollar Exchange Rate Depreciation (1960-1990)
Recession as a Tool to Correct Real Appreciation Under a Fixed Exchange Rate
Sustainability of a Fixed Exchange Rate Depends on Commitment to Disinflation Costs
Loss of Credibility in a Fixed Exchange Rate
Fixed Exchange Rates as a Constraint on Monetary Finance
Argentina's Frequent Use of Monetary Finance
Argentina's 1991-2001 Currency Board: An Experiment in Fixing the Exchange Rate
Argentina's 1991–2001 currency board represented a significant departure from its history of monetary financing. By fixing the exchange rate to the US dollar, creating new money to fund deficits became impossible, as it would have caused a depreciation and broken the peg. This policy, along with limited international borrowing capacity, compelled the government to enforce fiscal discipline, which eliminated its primary deficit and led to a surplus. However, the policy's long-term viability was undermined by a growing loss of competitiveness from real appreciation, as Argentine inflation remained above U.S. levels. This led to a severe recession and high unemployment, which, combined with a loss of credibility in financial markets, ultimately caused the policy's abandonment.
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Introduction to Macroeconomics Course
Ch.7 Macroeconomic policy in the global economy - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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Figure 7.16: Correlation between Exchange Rate Depreciation and CPI Inflation (2009-2019)
Necessity of Binding Institutional Constraints for Sustained Inflation Control
Argentina's 1991-2001 Currency Board: An Experiment in Fixing the Exchange Rate
Argentina's 1991-2001 Currency Board: An Experiment in Fixing the Exchange Rate
Argentina's 1991-2001 Currency Board: An Experiment in Fixing the Exchange Rate
Evaluating a Strategy to Restore Competitiveness
Policy Dilemma in a Fixed Exchange Rate Regime
A country with a fixed exchange rate has experienced several years of domestic inflation significantly above that of its main trading partners. As a result, its exports have become less competitive and its trade deficit is widening. If the government is committed to maintaining the fixed exchange rate, which of the following describes the necessary adjustment process to restore competitiveness?
A country operating under a fixed exchange rate has experienced a sustained loss of international competitiveness due to its domestic inflation rate being consistently higher than that of its trading partners. To correct this without altering the fixed exchange rate, the government initiates an internal adjustment. Arrange the following stages of this adjustment process in the correct chronological order.
A country with a fixed exchange rate and higher domestic inflation than its partners decides to induce a recession to regain competitiveness. The primary goal of this policy is to cause a nominal appreciation of its currency.
The Mechanism of Internal Adjustment
A country with a fixed exchange rate is experiencing a loss of competitiveness. To correct this without changing the exchange rate, it pursues a policy of internal adjustment. Match each stage or condition of this process with its most direct economic consequence.
The Price of Competitiveness
A country within a currency union (where the nominal exchange rate is fixed) is experiencing a persistent loss of international competitiveness. Its domestic inflation has consistently been higher than the union's average. To address this issue without leaving the union, the government implements significant cuts in public spending and raises taxes. What is the primary economic mechanism through which these policies are intended to restore competitiveness?
The Unraveling Peg
Argentina's 1991-2001 Currency Board: An Experiment in Fixing the Exchange Rate
Sustainability of an Anti-Inflationary Peg
A government successfully reduces hyperinflation by fixing its currency's exchange rate to that of a major, stable foreign currency. A year into the policy, while inflation remains low, the domestic economy has entered a deep recession with high unemployment, leading to significant political unrest. Based on this scenario, which factor poses the most critical threat to the long-term success of the fixed exchange rate policy?
Once a high-inflation country successfully stabilizes its price level by fixing its exchange rate, the most significant challenge to maintaining this stability over the long term is preventing a trade deficit from developing.
The Political Economy of Fixed Exchange Rates
The Trade-off of a Fixed Exchange Rate
Argentina's 1991-2001 Currency Board: An Experiment in Fixing the Exchange Rate
Market-Driven Interest Rate Gaps under a Non-Credible Fixed Exchange Rate
Currency Peg Under Pressure
A country maintains a fixed exchange rate, pegging its currency, the 'Lira', to a foreign currency, the 'Dollar'. Initially, the peg is viewed as stable. However, after a period of economic difficulty, financial market participants begin to widely anticipate that the government will be forced to devalue the Lira in the near future. Based on this change in market expectations alone, what is the most likely immediate outcome in the financial markets?
The Mechanics of a Speculative Attack
Interest Rates and Exchange Rate Credibility
In a fixed exchange rate system, a 'loss of credibility' primarily stems from an official announcement by the central bank that it plans to abandon the currency peg.
A country with a fixed exchange rate begins to experience significant economic challenges, leading financial markets to doubt the government's commitment to maintaining the currency peg. Arrange the following events into the logical sequence that typically unfolds as this loss of credibility intensifies.
A country with a fixed exchange rate is experiencing a period of economic difficulty. Which of the following developments would be the most direct and powerful indicator that financial markets specifically expect the currency peg to be abandoned in the future?
Foundations of a Currency Crisis
Evaluating Policy Responses to a Currency Credibility Crisis
Match each economic event or condition with its most likely consequence or role in a scenario where a fixed exchange rate is losing credibility.
Argentina's 1991-2001 Currency Board: An Experiment in Fixing the Exchange Rate
Fiscal Policy and Exchange Rate Stability
A country maintains a policy of pegging its currency's value to that of a major international currency. Faced with a significant budget shortfall, the government considers financing its spending by instructing the central bank to create new money. Why does this method of financing pose a direct threat to maintaining the pegged exchange rate?
Policy Constraints Under a Fixed Exchange Rate Regime
A country with a policy of maintaining its currency's value at a constant rate against a foreign currency decides to fund its government spending by creating new money. Arrange the following events in the logical sequence that would result from this policy decision.
Correlation between Monetary Base and CPI in Argentina (1960-2017) [Figure 7.21]
Amplified Impact of Monetary Finance with a Small Monetary Base
Argentina's 1991-2001 Currency Board: An Experiment in Fixing the Exchange Rate
Government Finance and Economic Consequences
A country's government consistently faces significant budget deficits, meaning its spending far exceeds its tax revenue. Furthermore, it is unable to borrow money from either domestic or international lenders to cover this shortfall. If the government decides to fund its spending by instructing its central bank to create new money, what is the most likely long-term consequence for the country's economy?
Analyzing the Link Between Fiscal Policy and Inflation in Argentina
Impact of Monetary Base Size on Inflation
A country's government is running a persistent fiscal deficit, meaning its expenditures are higher than its revenues. Additionally, both domestic and international investors are unwilling to lend to the government due to a history of defaults. Under these circumstances, why might the government choose to finance its deficit by creating new money, despite the significant risk of high inflation?
A country with a long history of funding its budget deficits by creating new money, leading to chronic high inflation, decides to adopt a new monetary system. Under this system, the value of its domestic currency is legally fixed to a stable foreign currency, and the central bank is prohibited from issuing new domestic currency unless it is fully backed by an equivalent amount of foreign currency reserves. How does this new system primarily impact the government's ability to finance its spending?
Evaluating a Government's Financing Options During a Crisis
Impact of Deficit Financing on the Money Supply
A government that consistently spends more than it collects in taxes can always avoid high inflation by simply borrowing the difference from financial markets, regardless of its economic history or credibility with lenders.
Calculating the Impact of Deficit Monetization
Learn After
Consequences of Abandoning Argentina's 2001 Currency Peg
Argentina's Fiscal Consolidation Under the 1990s Currency Board
A country with a history of high inflation implements a currency board, fixing its currency 1-to-1 with the U.S. dollar. The policy initially succeeds in curbing inflation and enforcing government budget discipline. However, over the next five years, the country's average annual inflation rate is 6%, while the U.S. inflation rate is 2%. Assuming the 1-to-1 peg is maintained, what is the most likely economic consequence that will threaten the long-term viability of this policy?
A country with a history of hyperinflation and large fiscal deficits implements a currency board, pegging its currency to a stable foreign currency. Arrange the following events in the correct causal sequence that leads from the policy's initial success to its eventual collapse.
Fiscal Discipline Under a Currency Board
Evaluating the Argentine Currency Board