Currency Crisis Case Write Up

Most countries develop an exchange rate system in order to stabilize their economy. The unidentified countries listed have pegged their currency to that of another country to promote economic growth. Fixed exchange rates allow importers and exporters to know exactly what kind of exchange rate they can expect for their transactions. This in turn helps to control inflation and temper interest rates, allowing an increase in trade. In addition, it’s important for a country’s exports to be greater than their imports to prevent a heavy trade deficit. Several factors help predict whether a country is going to experience a crisis. Recent historical data such as real interest rate, Real GDP, trade, investment as a percent of GDP, inflation rate, as well as the reserves as a percent of GDP all contribute towards determining the stabilization of the country.
As a group we believe that Country A’s recession last year will lead to a crisis in the near future. A strong indication is Country A’s high Real interest rates (averaging 6%) as well as low levels of GDP. Goods and services remain at a low value, providing us with the belief that this country will not be able to financially support itself for long. Country A is 1/6th the size of the United States and attempting to maintain a floating currency exchange rate system. We feel this puts Country A at a disadvantage in general because they are not strong enough or large enough to maintain a floating currency exchange rate system. In turn, investment as a percentage of GDP decreased by 16.15% during last year’s recession, indicating skepticism in Country A’s overall economic stability. In this type of situation, Country A would be less likely to undergo a recession if they had enough reserves to make up for significant loss of investment. Unfortunately, reserves are lower than desired and create no financial backup for a Country already experiencing a recession.
Country B will not undergo a currency crisis in the near future.