Question

Why did the exchange-rate peg lead to difficulties for the countries in the ERM after the German reunification?

Short answer

These situations also increased unemployment in these countries which finally led to the crisis in September 1992. So, the rationale for rate of exchange peg results in difficulties for the countries within the ERM after the German reunification is that the restricted control of the target countries' governments on the cash supply and rate.

Step-by-step solution

Concept Introduction

Pegging refers to the monetary policy or strategy that has targeting the worth or fixing the worth of the domestic currency to the foreign currency a bit like the gold standard. The changes within the value of the foreign currency will influence similar change within the targeted or domestic currency.

Explanation of Solution

After German reunification, inflationary pressure started arising in Germany that increased the speed of interest in Germany as in pegging, shocks to the anchor country will result in a corresponding change within the target country. So, the rise in rate occurred within the countries too, which was pegged with the Deutsche Mark. The increased rate of interest results in a decline within the demand which will cause decrease within the economic process of the countries in ERM.