Chapter 9: Exchange Rate Crises: How Pegs Work and How They Break Flashcards
Exchange Rate Crisis
A big depreciation
Banking Crisis
A crisis of the private sector
If banks and other financial institutions face adverse shocks, they may become insolvent, causing them to close or declare bankruptcy
Default Crisis
A crisis of the public sector
If the government faces adverse shocks, it may default and be unable or unwilling to pay the principal or interest on its debts
Twin Crises
When two out of the three crises (exchange rate crisis, banking crisis, and default crisis) occur together.
Triple Crises
When a banking crisis, a default crisis, and an exchange rate crisis all occur together
Domestic Credit
Central bank purchases
Reserves
Foreign assets
Central Bank Balance Sheet
The balance sheet for the central bank’s assets and liabilities
Assets
What is owed to you
Liabilities
What you owe
Floating Line
Cases in which the central bank balance sheet contains no reserves. It is called so because we assume that they have a floating exchange rate (45 degree line)
Fixed Line
A vertical line on the graph. It is so because the money supply is at the level necessary to maintain the peg
Currency Board
A fixed exchange rate that always operates with reserves equal to 100% of the money supply
Country Premium
Compensation for perceived default risk
Sterilization
Refers to the actions taken by a country’s central bank to counter the effects on the money supply caused by a balance of payments surplus or deficit
Insolvent Bank
A private bank is insolvent if the value of its liabilities exceeds the value of its assets
Bailout
Government coming to the rescue of a bank in a damaged state
Illiquid Bank
An illiquid bank holds some cash, but its loans cannot be sold (liquidated) quickly at a high price and depositors can withdraw at any time.
Bank Run
If too many depositors attempt to withdraw at once and a bank has insufficient cash on hand, then they are in trouble.
Lender of Last Resort
If a bank needs a loan to stay afloat but nobody will lend to them, they can turn to the central bank to lend to them
Sterilization Bonds
Since the central bank is not allowed to borrow, their net domestic assets can be less than zero. Thus, they issue sterilization bonds
First Generation Crisis Model
A sudden speculative attack on a fixed exchange rate, even though it appears to be an irrational change in expectations, can result from rational behavior by investors. This happens if investors foresee that a government is running an excessive deficit, causing it to run short of liquid assets or “harder” foreign currency which it can sell to support its currency at the fixed rate. Investors are willing to continue holding the currency as long as they expect the exchange rate to remain fixed, but they flee the currency en masse when they anticipate that the peg is about to end.
Speculative Attack
When investors sell all of their holdings of a particular currency
Fiscal Dominance
Monetary authorities ultimately have no independence
Second Generation Crisis Model
Equilibrium changes, which can happen due to multiple equilibria
Doubts about whether the government is willing to maintain its exchange rate peg lead to multiple equilibria, suggesting that self-fulfilling prophecies may be possible, in which the reason investors attack the currency is that they expect other investors to attack the currency.
Contingent Commitment
The country will peg, but if things get “bad enough,” then the government will let the exchange rate float rather than put the country through serious economic pain.
Self-Confirming Equilibrium
Combinations of investor beliefs and government actions for which the ex post outcome validates the ex ante beliefs
Corners Hypothesis
Only float or peg don’t pussy around with all the middle ground shit. Intermediate regimes suck
International Monetary Fund (IMF)
May lend to countries in difficulty if it thinks they can restore stability in a timely fashion with the help of a loan
