Suppose the target exchange rate set by the Fed is 150 yen per dollar. If the demand for dollars permanently decreases the Fed

Question

Quizplus · Accepted Answer

If the demand for dollars permanently decreases, it means that the supply of yen has increased compared to dollars. As a result, the exchange rate will decrease from 150 yen per dollar, making it difficult for the Fed to maintain the target rate. The Fed can temporarily meet the target by buying dollars, but it cannot do so permanently without violating interest rate parity and purchasing power parity, which would have negative consequences for the economy. Therefore, the only option is to accept that the target rate cannot be permanently maintained.

Suppose the Target Exchange Rate Set by the Fed Is