Exchange Rate and Banking Crises

Flashcards based on lecture notes about Exchange Rate Crises and Banking Crises

Exchange Rate Crisis

A sudden and significant devaluation of a country's currency, often associated with the failure of a fixed exchange rate system.

Peg (Fixed Exchange Rate)

A system where a country fixes its currency's value to another currency, maintained by the central bank's intervention in the foreign exchange market.

Central Bank Reserves

Foreign currency assets held by the central bank to stabilize the exchange rate and defend the peg.

Domestic Credit

Central bank lending to the domestic economy, typically through buying government bonds.

Sterilization

Central bank actions to counteract the effects of changes in reserves or domestic credit on the money supply.

Fiscal Dominance

Situation where government deficits dictate central bank policy, endangering the exchange rate peg.

Speculative Attack

A rush of investors selling domestic currency in anticipation of a devaluation.

Capital Flight

Rapid outflow of capital from a country, usually in response to economic or political instability.

Bank Insolvency

A bank's liabilities exceeding its assets, indicating insolvency.

Bank Illiquidity

A bank's inability to convert assets into cash quickly enough to meet withdrawal demands.

Deposit Insurance

Government guarantees on bank deposits to prevent bank runs and maintain stability.

Moral Hazard

Situation where protection from risk encourages riskier behavior.

Backing Ratio

The proportion of the money supply backed by reserves, indicating the currency's strength.

Currency Depreciation

When a peg breaks, the currency value can decrease suddenly and significantly, often 10-15% in advanced countries.

Twin Crises

Financial crises involving both an exchange rate crisis and a banking crisis.

Money Supply

Domestic credit plus reserves

Open Market Operations

Buying domestic bonds increases money supply; selling foreign assets decreases it

Illiquidity

Banks can't quickly sell assets to meet withdrawals

Insolvent

Banks' liabilities exceed assets

Deposit insurance

protects depositors, preventing panic but may encourage risky bank behavior

Reserve requirements

banks must keep cash reserves to meet withdrawals

Capital requirements

banks must keep enough capital to cover losses

Bank examinations

regulators check bank health regularly

Lender of last resort

central bank lends to banks in trouble to prevent panic

Government bailouts

rescue failing banks, sometimes at public expense