Question

3. An economy fixes its exchange rate at 5 pesos per US dollar. It has a balance of payment surplus of US$ 100 million (15%). What would happen to the exchange rate if the central bank does not do anything? a. b. What action would the central bank take to keep the exchange rate fixed? c. How would the central bank's action affect high-powered money and the money supply? ' What are the impacts of the change in the money supply on the interest rate, d. hand the balance of ayment sush short nun and in the long run?4 How does a central bank sterilize a balance of payment surplus? What is the purpose of sterilization?d e.

Answer 1

Fixes Exchange Rate at 5 persons per USD. BOP of surplus of US $ 100 million (15%) Since the economy has fixed the exchange rate, the central bank need not do anything to control the exchange rate. The economy follows a fixed exchange rate system and so nothing will happen to the exchange rate. The central bank will buy foreign currency at fixed exchange rate when there will be excess supply of foreign exchange and sell foreign currency at fixed exchange rate when there will be excess demand of foreign exchange. The Central bank may devaluate or revaluate the currency in the fixed exchange rates. To keep the exchange rate fixed the \r\n central bank has to hold a reserve of foreign exchange so as to provide foreign exchange in exchange for the domestic currently. It buy foreign currencies when there is excess supply of foreign exchange at the fixed exchange rate. It sells foreign currencies when there is excess