In 1995, the Thai Baht Is Pegged to a Basket

Essay

In 1995, the Thai baht is pegged to a basket of currencies. Assume that the baht exchange rate is set
at 25 baht per U.S. dollar. Thailand is experiencing rapid economic growth, with extensive ongoing foreign investment. Consumer price index (CPI) inflation in Thailand is somewhat higher than in the United States, and the current account in Thailand is in deficit. Nevertheless, Thailand has no problem maintaining its fixed exchange rate with the dollar.
a. Explain why the Thai baht does not depreciate as suggested by purchasing power parity (PPP).
b. Two years later, prospects for economic growth are much lower and investors are worried about the political and financial uncertainties in Thailand. Explain why the Thai baht depreciates strongly against the U.S. dollar.