Suppose the government of South Island has fixed the value of its currency, the Islandia, at $0.50 per Islandia, but the market equilibrium value of the Islandia is $0.25 per Islandia. In order to maintain the official value of the Islandia the Central Bank of South Island must either ________ domestic interest rates or purchase Islandia, which causes the supply of international reserves to ________.
A)raise; increase
B)raise; decrease
C)lower; decrease
D)lower; increase

Question

Quizplus · Accepted Answer

Note that at $.50 per Islandia, the Islandia is overvalued. To maintain this fixed rate, the government must increase the demand for the nation's currency. To increase demand for the Islandia, the government can either raise domestic interest rates or purchase more Islandia in the foreign exchange market, where the later decreases New South Island's international reserves.

Suppose the Government of South Island Has Fixed the Value