a country use fixed exchange rate between their currency with us. Pls reply me as soon as possible.?
Indonesia maintained a fixed exchange rate between their currency, the Rupiah, and the U.S. dollar. When currency speculators began selling Rupiah in exchange for dollars, Indonesia Central Bank reacted by increasing their domestic interest rates. Explain why defending the “peg” led to short-run increase in interest rates.
Please Explain to me fully.thx a lot.
my question is selling Rupiah buy Dollar!!!
A country maintains the fixed exchange rate by buying and selling its own currency off the open market. For example, if the value of the Rupiah increases above the desired rate, Indonesia will sell its reserves of Rupiah to the open market and buy the US Dollar, thus pushing up the Dollar and bring the Rupiah back down to the desired level.
However this only works if the country has sufficient reserves of foreign currencies. In your case, since Indonesia would want to push up the value of the Rupiah, they would Buy Rupiah and Sell Dollars right?
But if the country involved does not have sufficient reserves to buy back its own currency, it has to somehow increase the purchase of its currency.
In this case, to make the Rupiah more attractive to investors, Indonesia banks will offer attractive yields by increasing the interest rates.
Hence the purchase of Rupiah increases demand, pushing the value of the Rupiah up without Indonesia directly using its reserves.
In doing so, this will hurt the speculators who want the value of Rupiah to fall.
