Chapter 9: Exchange Rate Crises: How Pegs Work and How They Break

Question 1

Exchange Rate Crisis

Answer 1

A big depreciation

Question 2

Banking Crisis

Answer 2

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

Question 3

Default Crisis

Answer 3

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

Question 4

Twin Crises

Answer 4

When two out of the three crises (exchange rate crisis, banking crisis, and default crisis) occur together.

Question 5

Triple Crises

Answer 5

When a banking crisis, a default crisis, and an exchange rate crisis all occur together

Question 6

Domestic Credit

Answer 6

Central bank purchases

Question 7

Reserves

Answer 7

Foreign assets

Question 8

Central Bank Balance Sheet

Answer 8

The balance sheet for the central bank’s assets and liabilities

Question 9

Assets

Answer 9

What is owed to you

Question 10

Liabilities

Answer 10

What you owe

Question 11

Floating Line

Answer 11

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)

Question 12

Fixed Line

Answer 12

A vertical line on the graph. It is so because the money supply is at the level necessary to maintain the peg

Question 13

Currency Board

Answer 13

A fixed exchange rate that always operates with reserves equal to 100% of the money supply

Question 14

Country Premium

Answer 14

Compensation for perceived default risk

Question 15

Sterilization

Answer 15

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

Question 16

Insolvent Bank

Answer 16

A private bank is insolvent if the value of its liabilities exceeds the value of its assets

Question 17

Bailout

Answer 17

Government coming to the rescue of a bank in a damaged state

Question 18

Illiquid Bank

Answer 18

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.

Question 19

Bank Run

Answer 19

If too many depositors attempt to withdraw at once and a bank has insufficient cash on hand, then they are in trouble.

Question 20

Lender of Last Resort

Answer 20

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

Question 21

Sterilization Bonds

Answer 21

Since the central bank is not allowed to borrow, their net domestic assets can be less than zero. Thus, they issue sterilization bonds

Question 22

First Generation Crisis Model

Answer 22

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.

Question 23

Speculative Attack

Answer 23

When investors sell all of their holdings of a particular currency

Question 24

Fiscal Dominance

Answer 24

Monetary authorities ultimately have no independence

Question 25

Second Generation Crisis Model

Answer 25

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.

Question 26

Contingent Commitment

Answer 26

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.

Question 27

Self-Confirming Equilibrium

Answer 27

Combinations of investor beliefs and government actions for which the ex post outcome validates the ex ante beliefs

Question 28

Corners Hypothesis

Answer 28

Only float or peg don’t pussy around with all the middle ground shit. Intermediate regimes suck

Question 29

International Monetary Fund (IMF)

Answer 29

May lend to countries in difficulty if it thinks they can restore stability in a timely fashion with the help of a loan