Suppose a central bank prevents a depreciation of its currency by intervening in the foreign exchange market and buying its currency with foreign currency.Other things equal, this also causes the
A) domestic money supply to decrease and a decline in aggregate demand.
B) domestic money supply to increase and a decline in aggregate demand.
C) domestic money supply to decrease and a rise in aggregate demand.
D) domestic money supply to increase and a rise in aggregate demand.

Question

Quizplus · Accepted Answer

When a central bank buys its own currency in the foreign exchange market using foreign currency, it effectively removes its currency from circulation, leading to a decrease in the domestic money supply. A lower money supply can lead to higher interest rates, which can dampen investment and consumption, thus leading to a decline in aggregate demand.

Suppose a Central Bank Prevents a Depreciation of Its Currency