Under a system of fixed exchange rates, other things equal, if the par value of the fixed exchange rate is overvalued, then its central bank's effort to prevent the currency from ______ will lead to a (an) ______.
A) depreciating, increase in international reserves
B) depreciating, decrease in international reserves
C) appreciating, increase in international reserves
D) appreciating, decrease in international reserves

Question

Quizplus · Accepted Answer

If the par value of the fixed exchange rate is overvalued, the central bank will need to sell its own currency to maintain the pegged rate. This will lead to a decrease in international reserves as the central bank loses its foreign currency holdings in the process. Additionally, the selling of its currency will create excess supply and cause its value to depreciate.

Under a System of Fixed Exchange Rates, Other Things Equal