Explain what might be the drawbacks

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Suppose a country pegs its currency to the US dollar:

a. What happens to the country's real exchange rate if it experiences higher rates of inflation than the US and what is its effect on export competitiveness?

b. What happens to the country's nominal exchange rate vs. the US dollar, and vs. other currencies, if the US raises its interest rates?

c. As a result of the above developments (higher inflation and/or the US raising its interest rate), the country's currency is the subject of a speculative attack - a massive selloff of the currency. How can the government respond to maintain the peg?

d. If the country uses monetary policy to defend the peg, explain what might be the drawbacks of this.

Reference no: EM132413294

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