If two nations both peg to a center nation, and one devalues its exchange rate against the other partner (noncooperatively) 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 effect of the demand shock).
C) The devaluing nation will devalue more steeply and 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.
Ans: C) The devaluing nation will devalue more steeply and will see a larger increase in demand while its partner will suffer more (thus favoring the devaluing nation).
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