International Business. Crises and Exchange rate Essay

International Business. Crises and Exchange rate - Essay Example take down if there is no monetary agency, a government can create an inflation/debt crisis by excessive spending financed by interior(prenominal) and international borrowing. Mutatis mutandis, the identical considerations apply to a central bank that has the same degree of strictness as the currency board. (Betts, C. and Devereux, M, 2000)Second, world securities markets might crash as, for font, in October 1987 or in the October 1989 mini-crash. Many countries central banks amplifyed their stocks of high-powered money to provide naiantity to markets as investors fled from equities and corporate bonds and to high-quality assets such as U.S. T-bills and T-bonds. A currency board is unequipped to handle this type of crisis. At a time when it need to increase liquidity by expanding the domestic supply of money, a currency board is liable(predicate) to have domestic currency presented for conversion to the reserve c urrency, as international investors who fled to U.S. government securities did in the 1987 and 1989 crises. This flight reduces the stock of domestic currency as rise up as that part of the countrys international reserves that the currency board holds. In turn, domestic banks are less willing to provide liquid assets, and depositors are much interested in holding the reserve currency directly (or liabilities of the reserve-currency country). (Jan Winiecki, 2002).A domestic monetary agency parallel to the currency board might expand liquidity, as measured by the domestic money stock, through open market operations. There may well be a flight from domestic assets to reserve currency assets. The monetary agency can preserve the exchange rate by selling reserve currency obtained from selling its own liquid holdings denominated in the reserve currency or by borrowing reserve-currency assets, either commercially from foreign banks or from the reserve-currency central bank. A small count ry with yet a brief track record and low international holdings will likely find it difficult to preserve the exchange rate parity a monetary agency that has the holdings and power to preserve the parity is likely also to have the power to undercut currency board discipline over monetary and fiscal policy. Disturbances to Equilibrium Real Exchange Rates Third, the currency to which the board pegs may come under pressure from output market disturbances in the reserve-currency country. An example is the pressure on the European Exchange Rate Mechanism (ERM) after German reunification to either revalue the German mark or vilipend the other ERM currencies relative to the German mark. The interpretation of the September 1992 and July-August 1993 crises in the European Monetary System is that they arose in substantial part from the reunification of Germany. German amass demand rose substantially more than German aggregate supply. This increase caused upward pressure on German interest rates (with some observers disputation that the increase in interest rates was exacerbated by German reluctance to use taxes rather than bond issuance to finance the