Question

With realistic examples, explain how poor policy choices or fundamentals can trigger currency crises in Ghana?

Answer 1

A currency crises is a situation of dilemma for a country where the country's central bank does not have enough foreign exchange reserves to maintain its fixed exchange rate. If the country does not maintain its fixed exchange rate then it faces a speculative attack in the foreign exchange market. During currency crises the value of the country's currency falls which means 1 unit of country's currency will not be able to trade with the same amount of another currency as it used to do earlier. For example, if the value of 2 USD is equal to 1 EURO and the USD falls to 3 USD equal to 1 EURO then 1EURO will be able to buy 3 USD instead of 2 USD.

Poor policies such as

• improper decisions in monetary policy
• pegging of currency
• selling off huge foreign reserves including gold and silver
• implementing floating exchange rate

can cause serious financial crisis.

In 1994, when Mexican peso was devalued it faced huge currency crises in Latin America. Even Asian countries faced crisis in 1997, when the countries have taken high amount of external loans from the foreign market and were not able to pay back.

The Ghana's currency was highly fluctuating for more than a year which led to depreciation in the currency value losing more than 50% of its value in the foreign exchange market. The central bank of Ghana did not maintain a proper fixed exchange rate. The central bank's monetary policy failed to reduce the risk involved in floating of currency in-spite of the fact that it predicted currency crises. Here there is an important point to notice that the interest rate should be adjusted according to the risk predicted. This is one of the poor policy which led to the currency crises.

The central bank did not resolve the balance of payment problems when the central banks failed the government of Ghana should implement a proper fisical policy in order to maintain balance of payments, exchange reserves and the floating currency value. Taxes should be increases so that people will spend less when there is a depreciation. This was another poor policy which triggered the currency cries in Ghana.