Question

3. Suppose Mexican central bank chooses to peg the peso to the US dollar and commits...

3. Suppose Mexican central bank chooses to peg the peso to the US dollar and commits to a fixed exchange rate of $0.05 per peso (par value). Use a graph of dollar-peso foreign exchange market (you can put dollars per peso on the vertical axis) to show what happens when the Fed pursues contractionary monetary policy. Will peso become overvalued or undervalued? What kind of intervention should Mexican central bank employ to defend the peg?

Homework Answers

Answer #1

In following graph,

Contractionary monetary policy will increase domestic interest rate, which will increase foreign investment in Mexico. As a result, demand for peso will rise, shifting demand curve to right, increasing exchange rate and quantity of peso traded.

To reduce peso value, central bank has to sell peso and buy foreign currency such that its value falls to initial pegged rate.

In following graph, exchange rate (P) and quantity of Peso (Q) are shown along vertical and horizontal axis, respectively. D0 and S0 are initial demand and supply of Peso, intersecting at point A with initial exchange rate P0 and quantity of Peso Q0. When demand rises, D0 shifts right to D1, intersecting S0 at point B with higher exchange rate P1 and higher quantity of peso Q1.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Suppose Mexican central bank chooses to peg the peso to the US dollar and commits to...
Suppose Mexican central bank chooses to peg the peso to the US dollar and commits to a fixed exchange rate of $0.05 per peso (par value). Use a graph of dollar-peso foreign exchange market (you can put dollars per peso on the vertical axis) to show what happens when the Fed pursues contractionary monetary policy. Will peso become overvalued or undervalued? What kind of intervention should Mexican central bank employ to defend the peg?
"Suppose Mexico wants to fix its exchange rate relative to the US dollar. Suppose now the...
"Suppose Mexico wants to fix its exchange rate relative to the US dollar. Suppose now the Fed raises interest rates. If initially there is not a response in Mexican interest rates, what will happen initially to the nominal mexican peso (MXN) - dollar (USD) exchange rate?" "US bonds become less attractive, relative to Mexican bonds, therefore there will be an increase in demand for Mexican bonds and Mexican currency. The Mexican Central Bank (Banco de México) will buy USD at...
International Finance Imagine that oil prices have recently dropped to $48 per barrel. Suppose you are...
International Finance Imagine that oil prices have recently dropped to $48 per barrel. Suppose you are a member of the monetary policy committee of a small open economy, dependent on oil exports, which also wants to maintain a currency peg to the dollar. (a) Describe the pressures (in the form of appreciation or depreciation) that the domestic currency would face due to the decrease in oil prices. (Hint: Think about the effects of the lower oil prices−export prices−on the current...
Over the last 10​ years, the dollar has depreciated sharply​ vis-à-vis the euro. Suppose that in...
Over the last 10​ years, the dollar has depreciated sharply​ vis-à-vis the euro. Suppose that in the short run the Fed wanted both to defend the dollar​ (that is, stop its decline​ and/or cause it to​ appreciate) and stimulate investment. Can it achieve both of these goals simultaneously through monetary​ policy?   A. ​Yes, to stimulate investment the Fed will use expansionary policy that will raise interest rates. The higher interest rates will reduce investment into the United​ States, which will...
Please read the article and answer these questions. Thanks. Article: TESTING THE GLOBAL CENTRAL BANK SWAP...
Please read the article and answer these questions. Thanks. Article: TESTING THE GLOBAL CENTRAL BANK SWAP NETWORK In the last few weeks, the ECB has been drawing on its liquidity swap line with the Fed, first $308 million for a week, then $658 million for a week, and last week back down to $358 million. What’s that about? It’s not such a large amount. Bank of Japan borrowed more in the past, $810 million in March and $1528 million in...
Argentina and Ecuador: Understanding the Currency Crisis While fiscal policy is never far from the mind...
Argentina and Ecuador: Understanding the Currency Crisis While fiscal policy is never far from the mind of your average Argentine, who remembers the tough times and hyperinflation of the 1980s, the events of 2001 and 2002 have brought fiscal policy back to the forefront of public concern. Though the early 1990s may have been characterized by financial optimism, Argentina has been in a recession since Brazil's 1998 monetary crisis sent shockwaves across the regional and global markets. In early 2002,...