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

Under a fixed exchange rate system, the equilibrium exchange rate is maintained by the central bank buying or selling currency as necessary to keep the exchange rate from deviating from the fixed rate. If Canada's demand for Swiss francs shifts from D to D', there will be excess demand for Swiss francs at the fixed exchange rate. To maintain the fixed rate, the central bank will need to sell its reserves of Swiss francs to satisfy the demand, resulting in a balance of payments deficit for Canada.

Refer to the Above Diagram Where D and S Are