PROBLEM: Consider Denmark during the recent crisis that hit Europe. During this

Question

PROBLEM: Consider Denmark during the recent crisis that hit Europe. During this period, Denmark, like other European countries, faced the risk of a liquidity crisis. If such a crisis hits the economy, we know that one of the natural reactions of the Danish central bank would be to take measures to keep M1from falling, deepening the recession. Explain the restraints that Denmark, with a fixed exchange rate regime, faces in making such monetary decisions. In particular, explain the market forces that keep Danish central bank from taking expansionary monetary measures during liquidity crises.

Explanation / Answer

during the crisis, it has to support to supply money into the economy. for this they can cut taxes on people income in huge rates, they can increase government spending on different aspects, government spending should increase in many ways, it creates employment and money circulation. at the same time they need to work to increase its exports and minimize imports, for this exchange rate show impact on these exports and imports. they may use fixed or floating exchange rates for this. if they follow fixed exchange rate, it means they are strictly controlling the foreign exchange market also.

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