Whenever the central bank lends to solvent but illiquid private financial institutions, it does not endanger the peg. Why not?
A) The money demand and supply increase together, so interest rates are not affected, and the purchase of new domestic credit, when repaid, will restore the backing ratio.
B) The central bank finances the lending by selling reserves and the backing ratio is lower.
C) Private illiquid banks could borrow internationally, if needed, to repay their loans.
D) The peg is guaranteed by the administration, which stands ready to support it by selling reserves.

Question

Quizplus · Accepted Answer

When the central bank lends to solvent but illiquid private financial institutions, the money demand and supply increase together, so interest rates are not affected, and the purchase of new domestic credit, when repaid, will restore the backing ratio. This does not endanger the peg as the backing ratio remains intact.

Whenever the Central Bank Lends to Solvent but Illiquid Private