Under a Fixed Exchange Rate System, the Government Bears the Responsibility

question 61

Multiple Choice

Under a fixed exchange rate system, the government bears the responsibility to ensure that the BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves. If the sum of the first two accounts is GREATER THAN ZERO, a ________ demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervene in the foreign exchange market and ________ domestic currency for foreign currencies or gold so as to bring the BOP back near zero.

• A) surplus; sell
• B) surplus; buy
• C) deficit; sell
• D) deficit; buy

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Definitions:

Efficiency

The optimal allocation of resources to produce goods and services in a way that maximizes output with the least waste or cost.

ATC Curve

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The characteristic of a resource allocation where it is impossible to improve the situation of one party without worsening the situation of another.

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