In 2002 it looked like the Argentinean government might default on its debt (which eventually it did). Which of the following is consistent with what the open-economy macroeconomic model predicts?
A)This event should have raised Argentinean interest rates and caused the Argentinean currency to appreciate.
B)This event should have raised Argentinean interest rates and caused the Argentinean currency to depreciate.
C)This event should have lowered Argentinean interest rates and caused the Argentinean currency to appreciate.
D)This event should have lowered Argentinean interest rates and caused the Argentinean currency to depreciate.

Question

Quizplus · Accepted Answer

According to the open-economy macroeconomic model, when a country faces the risk of defaulting on its debt, investors become more reluctant to hold its debt, which makes it more expensive for the government to borrow money. This reduction in demand for the country's debt leads to an increase in interest rates. Additionally, uncertainty about the country's economic prospects causes investors to sell its currency, in turn leading to a depreciation in the currency's value. Therefore, choice B that states "This event should have raised Argentinean interest rates and caused the Argentinean currency to depreciate" is consistent with what the model predicts.

In 2002 It Looked Like the Argentinean Government Might Default