question about pegging dollars for a fixed exchange rate?
31. Suppose Country A pegs its currency to the dollar. If Country A wants to keep the exchange rate fixed, what are its options under each of the following scenarios? Is there an advantage to one of the options?
(A)U.S. interest rates rise.
(B)There is a recession in the United States so that household income falls.
(C)Country A experiences a positive wealth effect that raises consumer spending.
- OiyLv 68 months ago
if country A is China which has the biggest reserves on earth, the US interest rate will not be harmful at all. China will use the reserves against the capital flow, and the hedger must cry to death. In the case of B, the FED will try to depreciate the dollar using QE. The dollar will flee to emerging markets and create a strong local currency everywhere. The fixed exchange rate system will be dead overnight if the reserve is not big enough to defend it. And the case C of higher imports for country A must shake the trade deficit and the stability of the local currency. If the exchange rate is fixed, it has to fight against the hedgers day and night. Until the reserves are gone, also in the future market, the crisis get started like in Asia in 1995.