Propping Up the Argentinian Peso

Answer the following questions to check your understanding of the story.

What is happening to the peso as it approaches the upper limit of its flexible exchange rate band?

a) The peso is depreciating.

b) The peso is appreciating.

c) The U.S. dollar is depreciating.

d) The peso is neither depreciating nor appreciating as long as it stays inside the band.

Wrong! - As the peso approaches the upper limit of its flexible exchange rate band (in pesos per U.S. dollar), more pesos are needed to buy 1 U.S. dollar. Which currency is appreciating? Which currency is depreciating?

That's Right! - As the peso approaches the upper limit of its flexible exchange rate band (in pesos per U.S. dollar), more pesos are needed to buy 1 U.S. dollar. The peso is depreciating.

Why is Argentina's central bank using its scarce reserves to support the peso?

a) To increase economic growth by encouraging foreign investment in Argentina

b) To achieve a target inflation rate

c) To keep the real exchange rate constant

d) To increase net exports and decrease aggregate demand

Wrong! - How can the central bank use the peso exchange rate with the U.S. dollar to stabilize the Argentinian economy?

Well Done! - Argentina’s price level is influenced by its real exchange rate and the U.S. price level—two factors it cannot influence—and the peso exchange rate in terms of the U.S. dollar, which it can influence. If the central bank uses its scarce reserves to maintain the rate of change in the peso exchange rate, it can achieve a target inflation rate.

Why is Argentina’s central bank likely to replace the band with a more flexible exchange rate system?

Argentina’s central bank is _____________, which it can’t do indefinitely.

a) depleting its U.S. dollar reserves

b) depleting its peso reserves only

c) depleting its peso reserves and piling up U.S. dollar reserves

d) piling up U.S. dollar reserves only

Wrong! - What action is Argentina’s central bank taking to keep the peso within the band? Is it depleting its peso reserves or piling up U.S. dollar reserves?

Good Job! - To prevent the peso from moving outside the band, Argentina’s central bank is buying pesos with its U.S. dollar reserves. Eventually, the bank will run out of U.S. dollars and have to abandon the band in favor of a flexible exchange rate system.

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