Answers for the Examination Papers Essay Example | Topics and Well Written Essays - 2500 words

Answers for the Examination Papers - Essay Example The cornerstone of these attacks is a poor monetary policy of the government (the gap between monetary policy and fixed exchange rate). According to Krugman, the prerequisite for the currency crisis is the budget deficit that in turn is financed by the credits; this process may entail the depletion of the reserves of the currency (reserves of the currency to which a national one is pegged). If the domestic interest rate equals foreign interest rate, than the supply of the money caused by the expansion will be more than the demand on the national currency. The surplus of the domestic currency on the market leads to the increased demand on the foreign currency. In order to satisfy demand on the foreign currency, the national bank has to sell the reserves of the foreign currency. Once the reserves have been depleted, the national bank will have to abandon its fixed exchange rates policy as it will have no sufficient reserves to sustain it(Crznar, Currency crisis: theory and practice wit h application to Croatia). Certainly as several decades have passed since the formulation of this model by Paul Krugman it has been readjusted to reflect current trends and realities, however in view of many critics this theory has one important flaw: contention that a government could be a passive observer on the market and will do little or nothing at all to remedy monetary and fiscal problems of the country. Usually the government could readjust its monetary and fiscal policy to the exchange rate regime it maintains. Second generation model. In view of the crisis of European Monetary System in 1992, new theories of causes of currency crisis have been developed. According to this model, the government maintains fixed exchange rate regime as long as it deems necessary to do so( it might do it to decrease inflation or to establish more predictable environment for its importers and exporters. However, the government will certainly