When there is a banking crisis under a peg, the monetary authority may be tempted to bail out the banks. Why is this risky?
A) Banks are the least important entity in the financial sector, and attention should be paid to manufacturing, which is more important.
B) Banks are critical to the success of the economy, and when they are in bad shape, it is best to allow the weaker banks to fail and support the stronger ones.
C) The central bank would have to sell reserves to maintain the peg, and they could fall to an unsafe level.
D) The monetary authority would be forced to buy reserves in exchange for domestic currency-so there would be plenty of money in circulation.

Question

Quizplus · Accepted Answer

Bailing out banks during a crisis under a pegged exchange rate system can be risky because the central bank may need to sell foreign reserves to maintain the peg. If these reserves fall to an unsafe level, it could endanger the peg and the country's financial stability.

When There Is a Banking Crisis Under a Peg, the Monetary