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 $0.75 per Islandia. In order to maintain the official value of the Islandia the Central Bank of South Island must either ________ domestic interest rates or supply 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 $0.50 per Islandia, the Islandia is undervalued. To maintain this fixed rate, the government must increase the supply of the nation's currency. To increase the supply of the Islandia, the government can either lower domestic interest rates or supply additional units of Islandia by purchasing or increasing their holding of international reserves.

Suppose the Government of South Island Has Fixed the Value