Following an expansion of the money supply, a government committed to maintaining a fixed exchange rate must:
A)accept a surplus in its current account.
B)not use sterilized intervention.
C)increase its level of government expenditure and autonomous investments.
D)intervene in the foreign exchange market to sell foreign currency and buy domestic currency.

Question

Quizplus · Accepted Answer

In order to maintain a fixed exchange rate after an expansion of the money supply, the government must intervene in the foreign exchange market to sell foreign currency and buy domestic currency. This will help to counteract the increased supply of domestic currency and maintain the fixed exchange rate. Option A is not necessarily true as a surplus in the current account can put upward pressure on the domestic currency and threaten the fixed exchange rate. Option B is incorrect because sterilized intervention involves offsetting the effects of currency interventions on the money supply, which could undermine the fixed exchange rate. Option C would likely increase demand for imports and put downward pressure on the domestic currency, which is also not conducive to maintaining a fixed exchange rate.

Following an Expansion of the Money Supply, a Government Committed