Question

How can exchange-rate targets lead to a speculative attack on a currency?

Short answer

If investors believe that financial organization isn't holding the foreign reserves, they'll target this nation for speculative attack and for this, they sell their local currency to the financial organization. Once the financial organisation is out of foreign reserve it'll not be ready to purchase local currency at fixed rate and therefore the currency's rate will start floating that may cause depreciation in currency yet. Thus, during this way rate targets cause a speculative attack on a currency. Thus, charge per unit targets cause a speculative attack on a currency.

Step-by-step solution

Concept Introduction

Rate target refers to the monetary policy or strategy that features targeting the worth or fixing the worth of the domestic currency to the foreign currency similar to the gold standard. The changes within the value of the foreign currency will influence similar change within the targeted or domestic currency. A speculative attack refers to the sudden and enormous amount of selling of a domestic currency or acquisition of the domestic currency by the foreign investors.

Explanation of Solution

Speculative attacks generally happen with the target countries that have pegged their currencies to a different country's currency. The country with charge per unit target uses fixed rate system and needs to intervene within the interchange market to take care of the speed. it's to carry as many foreign reserves to satisfy the sudden demand for the domestic currency.