The central bank of a country with a balance of payments deficit may intervene in foreign exchange markets by selling some of its foreign currency holdings.If it wants to sterilize the intervention the central bank must also

Question

Quizplus · Accepted Answer

When a central bank sells foreign currency, it increases the supply of domestic currency in the market. If this increase is not offset, it can lead to inflation. Therefore, to sterilize the intervention, the central bank needs to remove the excess domestic currency from the market. This can be done by purchasing government bonds from domestic banks, which reduces the money supply in the market. Therefore, choice A is the best answer.

The Central Bank of a Country with a Balance of Payments