The first-generation currency crisis models have shown that an exchange rate collapse can be the inevitable result of government policies inconsistent with maintaining a fixed exchange rate permanently. In such cases, simple economic theory may allow us to predict the exact date of a crisis through careful analysis of the government policies and the market’s rational response to them.
(a) Describe with the help of an economic model how the exact date of the exchange rate crisis can be determined in such models. Be sure to describe the policy of the government and the reaction of the Central Bank to that policy in your model. (6 marks)
(b) Draw separate diagrams to illustrate the path of each of the following variables before and after the crisis: exchange rate, money supply, foreign exchange reserves. (5 marks)
a) Economic model exchange rate crisis includes:
b) Refer to the diagram
The first-generation currency crisis models have shown that an exchange rate collapse can be the inevitable...
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