A banking crisis often threatens a fixed exchange rate (or peg). Why?
A) Banks have to provide funds to maintain the fixed exchange rate.
B) The central bank may have to bail out insolvent banks by inflating the currency, which could cause a loss of reserves.
C) The central bank has to close relationships with foreign banks, and there is no way to implement the fixed exchange rate system.
D) The banking crisis means that domestic banks hold onto foreign currency reserves rather than exchanging them with the central bank.

Question

Quizplus · Accepted Answer

A banking crisis often leads to a situation where the central bank has to bail out insolvent banks. This may involve inflating the currency or increasing the money supply, which can lead to a loss of reserves. In turn, this loss of reserves can make it difficult for the central bank to maintain a fixed exchange rate. As a result, a banking crisis often threatens a fixed exchange rate.

A Banking Crisis Often Threatens a Fixed Exchange Rate (Or