Refer to the above diagram where D and S are Canada's demand for and supply of Swiss francs.At the equilibrium exchange rate, E, Canada's balance of payments is in equilibrium.Under a system of fixed exchange rates, the shift in demand from D to D' will cause:
A)Canada to increase its stocks of international monetary reserves.
B)a Swiss balance of payments deficit.
C)a Canadian balance of payments deficit.
D)a Canadian balance of payments surplus.

Question

Refer to the above diagram where D and S are Canada's demand for and supply of Swiss francs.At the equilibrium exchange rate, E, Canada's balance of payments is in equilibrium.Under a system of fixed exchange rates, the shift in demand from D to D' will cause:
A)Canada to increase its stocks of international monetary reserves. 
B)a Swiss balance of payments deficit. 
C)a Canadian balance of payments deficit. 
D)a Canadian balance of payments surplus.

Quizplus · Accepted Answer

A shift in demand from D to D' implies an increased demand for Swiss francs by Canada. Under a fixed exchange rate system, the central bank of Canada must intervene in the foreign exchange market by purchasing Swiss francs to maintain the fixed exchange rate. This will lead to a decrease in Canada's international reserves and a balance of payments deficit. On the other hand, there is no information to suggest that there will be a Swiss balance of payments deficit (choice B) or a Canadian balance of payments surplus (choice D) as a result of this shift in demand.

Refer to the Above Diagram Where D and S Are