Describe a situation in which a one-way speculative gamble would be possible and explain the effects that this type of speculation would have on a country trying to maintain its fixed exchange rate.
What will be an ideal response?
POSSIBLE RESPONSE: When a currency clearly is in danger of being devalued, the situation may give rise to a one-way speculative gamble. If speculators know that a currency could not significantly rise in value, the speculator can sell the currency in the spot or forward market. If the currency does not drop in value, there is not much to lose. If the currency is devalued, it can bring the investors large speculative profits. With little to lose and much to gain, speculators can gang up on a currency that is moving into a crisis phase. As speculators bet against the currency, the government must increase its intervention to defend the fixed exchange rate, selling foreign currency and buying its own currency. The government is running down its holdings of official reserve assets at a faster rate. If this continues, the government usually must surrender, and allow devaluation or depreciation of its currency.
You might also like to view...
The greater the interest rate
A) the greater the present value of a sum to be received a year in the future. B) the greater the opportunity cost of another dollar of current consumption. C) the more a dollar invested today will be worth a year from now. D) the lower the discount rate.
Refer to Scenario 17.1. If the threshold educational level y* is set at 7,
A) only individuals in Group A will attain it. B) only individuals in Group B will attain it. C) individuals in both groups will attain it. D) no individuals will attain it. E) some fraction of individuals in each group will attain it.
Under flexible exchange rates, the exchange rate is set by
A) the International Monetary Fund. B) the U.S. Federal Reserve's Board of Governors. C) the intersection of demand and supply curves in the currency markets. D) negotiations among central banks of the major industrial powers.
In general, the substitution effect of an increase in the price of a normal good:
A. will cause the individual to buy more of that good because they have relatively more income. B. will cause the individual to buy less of that good because they have relatively less income. C. will cause the individual to buy more of that good and less of others because it is relatively less expensive. D. will cause the individual to buy less of that good and more of others because it is relatively more expensive.