A danger to the peg is a situation in which the central bank lends to insolvent private financial institutions to bail them out of crises. Why might this cause a problem?
A) The private financial institutions are often corrupt and should not be bailed out.
B) Foreign investors are helped and domestic investors harmed.
C) It requires a drawdown of foreign reserves to maintain the peg, lowering the backing ratio.
D) The central bank is assuming more than its share of political power, which can cause problems down the road.

Question

Quizplus · Accepted Answer

Lending to insolvent private financial institutions depletes the central bank's foreign reserves, which are needed to maintain the peg. This can lower the backing ratio, making it difficult for the country to defend the peg and potentially leading to a devaluation or abandonment of the peg.

A Danger to the Peg Is a Situation in Which