Achieving Low Inflation by Pegging to a Stable Anchor: The US Dollar Example
When a country pegs its currency to that of an economy with a history of low and stable inflation, like the United States, it can successfully import that price stability. As predicted by theory and shown in data like Figure 7.16, this policy results in the country's domestic inflation rate converging toward the low rate of the anchor economy (around 2% for the U.S.).
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Achieving Low Inflation by Pegging to a Stable Anchor: The US Dollar Example
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Achieving Low Inflation by Pegging to a Stable Anchor: The US Dollar Example
Monetary Policy Strategy Analysis
Country A has historically experienced high and volatile inflation. In an effort to stabilize its economy, its central bank decides to implement a policy where its currency's value is held constant against the currency of Country B, a large trading partner with a long history of low and stable inflation. Assuming this policy is maintained successfully, what is the most likely long-term outcome for Country A's inflation rate?
Mechanism of Inflation Convergence
If a country with a history of stable, low prices decides to implement a fixed exchange rate system by pegging its currency to that of a country experiencing persistently high inflation, the low-inflation country can expect to maintain its price stability.
A developing nation's central bank wants to curb its chronic high inflation and achieve long-term price stability. It plans to implement a fixed exchange rate system and is considering pegging its currency to one of two major trading partners:
- Country A has an average annual inflation rate of 10% with significant fluctuations.
- Country B has a consistent average annual inflation rate of 2%.
Which of the following represents the most effective strategy and the correct reasoning for it?
A country maintains a fixed exchange rate with a large economic partner. For a sustained period, the country's domestic inflation rate is 5%, while the partner's inflation rate is 2%. What is the most likely consequence of this inflation differential for the country with the higher inflation rate?
Sustainability of a Fixed Exchange Rate
Predicting Inflation in a Currency Union
Challenges to Inflation Convergence
Match each economic scenario involving a country's monetary policy to the most likely long-term consequence for its domestic inflation rate, assuming the described policy is successfully maintained.
Learn After
A developing nation is experiencing persistent and high domestic inflation, averaging 20% annually. The nation's central bank is considering a new policy to achieve price stability: pegging its currency at a fixed rate to the U.S. dollar, which is backed by an economy with a stable and low inflation rate of around 2%. Based on the relationship between exchange rate regimes and domestic price levels, what is the most likely long-term outcome if this policy is successfully implemented?
Evaluating a Currency Peg Policy
Inflation Outcomes and Exchange Rate Policies
The Mechanism of Imported Price Stability
Match each exchange rate policy scenario for a small, open economy with its most likely long-term impact on the domestic inflation rate.