Question

2. In the wake of the currency crises that afflicted several Asian economies, many open-economy macroeconomists have expressed the view that emerging economies that have become highly integrated with world capital markets have to choose between floating rates or “hard” fixed exchange rate pegs, because “soft” pegs are too vulnerable to speculative attacks. Explain:

a. Why the degree of capital mobility might affect the sustainability of “soft” currency pegs.

b.    Why a “hard” peg might be more sustainable.

Answer 1

a)

Soft currency pegs is between floating currency and fixed peg rate. In other words, currency value moves within fixed band. hence, currency rate keeps moving within this bank. Any inkling of risk leads to the ouflow of currency which depreciate value of currency. likewise, improved fundamental of economy causes

b)

Hard peg currency is aligned to any particular currency or basket of currencies. Inflow or outflow foreign currency does not affect value of domestic currency. Hence, it is relatively stable and more sustainable.