Question

a) why is the home interest rate higher under a noncredible peg than under a credible peg?

b) Is it more costly to maintain a non credible peg than a credible peg? Explain

c) what the central bank of a country with fixed exchange rate regime has to do to avoid a currency crisis.

Answer 1

Noncredible peg is risky and that's why they provide higher interesrt rate while credible peg have enough credibility and thus they provide low interest rate but they are safe to investment .credible pegg including government security etc.

Yes it is more costly to maintain as non credible peg are more risky that why these are provide with higher interest rate as well as higher cushion in case of bursts scenerio of NPA or insolvency etc. While credible pegg are safer and cheaper than this.

Fixed exchange rate fixed the currency exchange rate within a band for movement and thus it protect economy from fluctuations of currency and this stabilize the economy. Thus this is helping to avoid currency crisis As through this currency is devalued enough in a band to benifit from Beneficial export and prevent costly import