In emerging markets, a banking crisis threatens the peg when a bailout occurs because:
A) the central bank will act too cautiously.
B) the central bank will bail out other financial firms as well.
C) the central bank cannot then lend to other solvent banks.
D) fear of unsafe banks might encourage depositors to convert funds into foreign currency deposits offshore.

Question

Quizplus · Accepted Answer

When a banking crisis occurs in emerging markets and a bailout is implemented, there is a risk that depositors may lose confidence in the banking system and choose to withdraw their funds to convert them into foreign currency deposits offshore. This leads to a decrease in the demand for the local currency, which can threaten the peg. This is why Option D is the best choice. Option A is incorrect because the central bank's cautiousness does not necessarily threaten the peg. Option B is incorrect because the bailout of financial firms does not have a direct impact on the peg. Similarly, option C is incorrect because the central bank's inability to lend to solvent banks does not necessarily threaten the peg.

In Emerging Markets, a Banking Crisis Threatens the Peg When