In 2002 it looked like the Argentinean government might default on its debt (which eventually it did).The open-economy macroeconomic model predicts that this should have
A)raised Argentinean interest rates and caused the Argentinean currency to appreciate.
B)raised Argentinean interest rates and caused the Argentinean currency to depreciate.
C)lowered Argentinean interest rates and caused the Argentinean currency to appreciate.
D)lowered Argentinean interest rates and caused the Argentinean currency to depreciate.

Question

Quizplus · Accepted Answer

The prediction of the open-economy macroeconomic model is that a possible default by a government would increase the perceived risk of investing in that country, leading to a decrease in foreign investment and an increase in the demand for domestic currency to hold domestic assets. This increased demand for the domestic currency should cause it to appreciate. At the same time, the government may need to raise interest rates to attract enough domestic investors to take up new debt issues, otherwise they may have to monetize their debt, which would contribute to inflation, and further reduce confidence in the economy.

In 2002 It Looked Like the Argentinean Government Might Default