One of the things we learned about in class is the trilemma which states that if a country pegs its exchange rate to a base country’s currency and allows the free flow of capital in and out of the country, then it follows that the country’s interest rate will be the same as that of the base country (ignoring the sovereign risk premium). In other words, a nation that has a pegged exchange rate loses the ability to determine its own course on monetary policy.
The pandemic has created both demand and supply shocks that are huge and negative. In countries with floating exchange rates, central banks have literally thrown the book at the problem, using every possible tool of monetary policy to support the economy through these rough times.
But what about countries that have a fixed exchange rate?
They have NO ability to use traditional “interest rate” policies, which leaves them incredibly vulnerable.
How have such countries navigated the last 18 months? Is their economic performance worse than those countries whose currencies float? If not, how come?
This assignment does not ask you to answer these questions in general but rather to pick a country with a fixed exchange rate and compare what it has done and how it has done (from an economic standpoint) compared to a neighboring or similar nation that has had the benefit of being able to chart its own course with respect to interest rates.
Just as an example, in Chapter 8 of the text there is an analysis of the relationship between output volatility and exchange rate regime. A similar comparison might be part of what you investigate for this paper.
