Chap 9\ Flashcards
Why does the level of money demand fluctuate ?
- 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
Definition of ER crisis:
- 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
what is a currency board system ?
- A fixed ER that always operates with the reserves equal to 100% of the money supply
What is the home central bank’s sole liability ?
- The money in circulation
how was the banking crisis in Argentina 1994?
- 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
What is the banking ratio ?
- It is the measure that indicated the fraction of the money supply that is BACKED by reserves on the central bank sheet.
Definition of domestic credit :
- the loaning of foreign money to the domestic economy that was buy by the central bank (CHECK)
what cause that the currency premiums fluctuate ?
- The credibility of monetary policies and the credibilities of property rights
What recent history can say about fixed ER?
- It success for few years then it breaks
- average of 5 years
What evidence shows about the occurrence of crisis ?
- 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
What is a bank insolvency ?
- when a bank’ liabilities (costumer deposits) exceeds the value of assets
what is the meaning of “second generation crisis model”?
- 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
what is illiquidity in a bank ?
- When the assets of the bank cannot been sell (liquidate ) fast enough , even if it solvent
What the economist refers to Contagion, in the global markets ?
- It is when crisis in some parts of the global capital markets trigger adverse changes in other places
What happens in the event of a shock to home output or foreign interest rate ? (STEPS )
- 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
what is sterilization by the central bank ?
- It the term used when the central bank intervene in to prevent depreciation in monetary peg
what causes an ER crisis apart from depreciation ?
- Insolvency (banking crisis ): private market
- default crisis (sovereign debt crisis) : government
what lessons can be arrive from a speculative attack ?
- It explains why ER crisis happen without alert
- Explains the false sense of security in the reserves
Graphical Analysis of the central bank balance sheet :
lines
- If ER is floating : 45 degree
- If ER is fixed: vertical line
Preliminaries and assumptions about the mechanics of Fixed ER
- 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)
what is the meaning of “first generation crisis model”?
- 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 )
what kind of peg are consider the currency boards ?
- they are consider a hard peg because their main gol is to give greater resilience in a money demand shock
what is the term “Fiscal Dominance” ?
- when the monetary authorities have no independence because the only lender left is the central bank
What term is use when a peg is defended?
- The peg is a contingent commitment
- which means that is the ER get “bad enough”, the government will let the ER float
what is the problem with the contingent commitment in pegs?
- The problems is that everyone know it and will adjust their expectation accordingly
what the currency board operation does ?
- It keeps reserves at maximum 100%, so the central bank can cope with any shock to the money demand
