If two nations both peg to a center nation, and one devalues its exchange rate against the other partner (cooperatively) and to the center as a result of a demand shock, what is the effect?
A) The center nation will require that the two line up their rates.
B) The devaluing nation will see an increase in demand while the other partner sees a decrease (thus sharing the impact of the demand shock).
C) The devaluing nation will see a larger increase in demand while its partner will suffer more (thus favoring the devaluing nation).
D) Both nations will suffer more because the center nation will match the devaluation, thus negating the effect.

Question

Quizplus · Accepted Answer

When one nation devalues its exchange rate against the other partner (cooperatively) and to the center as a result of a demand shock, it becomes cheaper for the devaluing nation to export its goods, which may increase demand for its products. On the other hand, it may become more expensive for the partner nation to import goods from the devaluing nation, possibly decreasing demand for its products. However, since both nations are pegged to a center nation, the center nation may require that they align their exchange rates. This aligning may not necessarily negate the effect of the devaluation, but it may prevent further devaluations.

If Two Nations Both Peg to a Center Nation, and One