Chap 9\

Question 1

Why does the level of money demand fluctuate ?

Answer 1

• The fluctuation come from home output or foreign interest rate
• Since output fluctuate more in emerging markets and developing countries, a prudent level of reserve is higher
• If the peg is no credible or the interest parity fails to hold , foreign and home interest are not equal and additional disturbance can be cause by the spread

Question 2

Definition of ER crisis:

Answer 2

• Big “Depreciation”
• In advance economies it can be 10% to 15%
• In emerging economies it can be 20% to 25%
• The magnitude of the crisis is measured in depreciation of currency

Question 3

what is a currency board system ?

Answer 3

• A fixed ER that always operates with the reserves equal to 100% of the money supply

Question 4

What is the home central bank’s sole liability ?

Answer 4

• The money in circulation

Question 5

how was the banking crisis in Argentina 1994?

Answer 5

• Immediately after the Mexican Tequila crisis
• Argetina’ reserve drained
• Doubt in the fixed ER
• Raising the currency premiums (draining more reserves)
• The fear of a banking crisis and a ER crisis incentives to used other currency
• Depreciation increase, putting Argentina close to the floating line ( a place when the reserve run out)
• IMF intervention

Question 6

What is the banking ratio ?

Answer 6

• It is the measure that indicated the fraction of the money supply that is BACKED by reserves on the central bank sheet.

Question 7

Definition of domestic credit :

Answer 7

• the loaning of foreign money to the domestic economy that was buy by the central bank (CHECK)

Question 8

what cause that the currency premiums fluctuate ?

Answer 8

• The credibility of monetary policies and the credibilities of property rights

Question 9

What recent history can say about fixed ER?

Answer 9

• It success for few years then it breaks

- average of 5 years

Question 10

What evidence shows about the occurrence of crisis ?

Answer 10

• Stat evidence shows that after one crisis the likelihood of other is greater (in other sector )

ER crisis —–> banking crisis and/or default crisis

banking crisis and/or default crisis ——> ER crisis

• Called twin crisis , also triple crisis

Question 11

What is a bank insolvency ?

Answer 11

• when a bank’ liabilities (costumer deposits) exceeds the value of assets

Question 12

what is the meaning of “second generation crisis model”?

Answer 12

• It refers when the peg is broken for unknown reasons at first, even when the policy is rational and purposeful .
• Systematic problems , speculative attack, etc

Question 13

what is illiquidity in a bank ?

Answer 13

• When the assets of the bank cannot been sell (liquidate ) fast enough , even if it solvent

Question 14

What the economist refers to Contagion, in the global markets ?

Answer 14

• It is when crisis in some parts of the global capital markets trigger adverse changes in other places

Question 15

What happens in the event of a shock to home output or foreign interest rate ? (STEPS )

Answer 15

• A output fall or foreign interest rate hike are treated as EXOGENOUS SHOCK
• Suppose that this lead to an ENDOGENOUS DECREASE in money demand
• The fall in money demand would lower the interest rate in the money market and put depreciation pressure at home currency
• To maintain peg, interest rate must not change. Therefore, it start selling foreign reserves in exchange for cash

Question 16

what is sterilization by the central bank ?

Answer 16

• It the term used when the central bank intervene in to prevent depreciation in monetary peg

Question 17

what causes an ER crisis apart from depreciation ?

Answer 17

• Insolvency (banking crisis ): private market

- default crisis (sovereign debt crisis) : government

Question 18

what lessons can be arrive from a speculative attack ?

Answer 18

• It explains why ER crisis happen without alert

- Explains the false sense of security in the reserves

Question 19

Graphical Analysis of the central bank balance sheet :

lines

Answer 19

• If ER is floating : 45 degree

- If ER is fixed: vertical line

Question 20

Preliminaries and assumptions about the mechanics of Fixed ER

Answer 20

• The ER is fixed ( 1 peso = 1 dollar )
• Central bank control ( control money by selling assets )
• The central bank have foreign reserves (if not peg is broken, and ER become floating )
• Foreign internet rate = Home interest rate (if peg holds)
• We assume that output and income is exogenous and denoted Y (disposable income)
• Stable foreign price level P = 1 (all time) (price stickiness) (PPP)
• The money market is in equilibrium ( M/P = L(i).Y)
• No financial system (only central bank)
• Only money is currency M0 (monetary base)

Question 21

what is the meaning of “first generation crisis model”?

Answer 21

• It refers when peg system break because of mismanagement or misinterpretation from the authorities
• Also expectation and beliefs in future policies
• Also can be on purpose (process to change to nominal voluntary )

Question 22

what kind of peg are consider the currency boards ?

Answer 22

• they are consider a hard peg because their main gol is to give greater resilience in a money demand shock

Question 23

what is the term “Fiscal Dominance” ?

Answer 23

• when the monetary authorities have no independence because the only lender left is the central bank

Question 24

What term is use when a peg is defended?

Answer 24

• The peg is a contingent commitment

- which means that is the ER get “bad enough”, the government will let the ER float

Question 25

what is the problem with the contingent commitment in pegs?

Answer 25

• The problems is that everyone know it and will adjust their expectation accordingly

Question 26

what the currency board operation does ?

Answer 26

• It keeps reserves at maximum 100%, so the central bank can cope with any shock to the money demand