Critical Thinking Questions
Why would a nation dollarize—that is, adopt another country’s currency instead of having its own?
Can you think of any major disadvantages of dollarization? How would a central bank work in a country that has dollarized?
If a country’s currency is expected to appreciate in value, what would you think will be the impact of expected exchange rates on yields, for example, the interest rate paid on government bonds, in that country? Hint—Think about how expected exchange rates change and interest rates affect demand and supply for a currency.
Do you think that a country experiencing hyperinflation is more or less likely to have an exchange rate equal to its purchasing power parity value when compared to a country with a low inflation rate?
Suppose a country has an overall balance of trade so that exports of goods and services equal imports of goods and services. Does that imply that the country has balanced trade with each of its trading partners?
We learned that monetary policy is amplified by changes in exchange rates and the corresponding changes in the balance of trade. From the perspective of a nation’s central bank, is this a good thing or a bad thing?
If a developing country needs foreign capital inflows, management expertise, and technology, how can it encourage foreign investors and at the same time protect itself from capital flight and banking system collapse, as happened during the Asian financial crisis?
Many developing countries, like Mexico, have moderate to high rates of inflation. At the same time, international trade plays an important role in their economies. What type of exchange rate regime would be best for such a country’s currency as compared with the U.S. dollar?
What would make a country decide to change from a common currency, like the euro, back to its own currency?