Britain joined the ERM in 1990, and the German Bundesbank conducted a contractionary monetary policy to curb inflation pressure in 1990-1992. Interest rates in Germany ____, forcing Britain to ______.Group of answer choicesfell; reduce its interest rates to maintain its currency peg with the German Markrose; reduce its interest rates to maintain its currency peg with the German Markrose; raise its interest rates to maintain its currency peg with the German Markfell; raise its interest rates to maintain its currency peg with the German Mark
Question
Britain joined the ERM in 1990, and the German Bundesbank conducted a contractionary monetary policy to curb inflation pressure in 1990-1992. Interest rates in Germany ____, forcing Britain to ______.Group of answer choicesfell; reduce its interest rates to maintain its currency peg with the German Markrose; reduce its interest rates to maintain its currency peg with the German Markrose; raise its interest rates to maintain its currency peg with the German Markfell; raise its interest rates to maintain its currency peg with the German Mark
Solution
The answer is "rose; raise its interest rates to maintain its currency peg with the German Mark".
Here's the step-by-step reasoning:
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When the German Bundesbank conducted a contractionary monetary policy, it would have reduced the money supply in Germany. This would have increased interest rates in Germany, as there would be less money available for lending.
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Britain, having joined the ERM, had committed to maintaining a fixed exchange rate with the German Mark. When interest rates rose in Germany, this would have attracted investors to move their money from Britain to Germany to take advantage of the higher interest rates.
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This capital outflow from Britain would have put downward pressure on the British pound, threatening the fixed exchange rate with the German Mark.
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To counteract this and maintain the currency peg, Britain would have had to raise its own interest rates to make British investments more attractive and prevent further capital outflow.
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Therefore, interest rates in Germany rose, forcing Britain to raise its interest rates to maintain its currency peg with the German Mark.
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