Question 1
(a) Analyse the main causes of high inflation in developing economies?
(b) Assess how monetary policy and exchange rate policies can be used to maintain a target of low inflation and currency stability in emerging markets?
(a) Discussion should relate to how
. •Inflation is caused by financing fiscal deficits through money supply growth.
. •Seigniorage revenue is gained by governments creating inflation from money
supply growth as a form of taxation.
.
(b) Discussion should relate to the policy trilemma of the open economy, especially how fixed exchange rates are incompatible with autonomous use of monetary policy under capital mobility. Institutional design (e.g. central bank independence) for conduct of monetary policy is crucial for achieving low inflation and currency stability.
.
Question 2
. (a) Evaluate the roles of liquidity risk and deposit insurance in contributing to bank failures in emerging markets
. (b) Assess the importance of regulatory and institutional reforms in contributing to greater financial stability and integration in emerging markets?
(a) The discussion should relate to the risk taking incentives of banks as a result of moral hazard, specifically
•the role of liquidity risk (lending long and borrowing short)
•the role of deposit insurance to avoid bank runs, etc.
（b）Discussion should focus on the policy prescriptions suggested by de la Torre (2007) seeking to attain financial sector stability in emerging markets in the wake of recent financial crises, e.g. the four recommendations include.
•convergence of regulations towards international standards and codes
•emphasis one institutional and regulatory pre-conditions.
•exchange rate flexibility giving autonomy of monetary policy.
•fostering the development of domestic currency debt markets.
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