Suppose the government of New Country has fixed the value of its currency, the New Peso, at $1 per New Peso, but the market equilibrium value of the New Peso is $2 per New Peso. In order to maintain the official value of the New Peso the Central Bank of New Country must either _____ domestic interest rates, or ________the supply of international reserves by purchasing New Pesos

Question

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Note that at $1 per New Peso, the New Peso is undervalued. To maintain this fixed rate, the government must increase the supply of the nation's currency. To increase the supply of New Pesos, the government can either lower domestic interest rates or supply additional New Pesos by purchasing or increasing their holding of international reserves.

Suppose the Government of New Country Has Fixed the Value