Suppose the target exchange rate set by the Fed is 150 yen per dollar. If the demand for dollars permanently decreases, then the Fed
A) can permanently meet the target by selling dollars.
B) can permanently meet the target by buying dollars.
C) must violate both interest rate parity and purchasing power parity to permanently meet the target.
D) cannot permanently maintain the target rate.

Question

Quizplus · Accepted Answer

To permanently maintain a fixed exchange rate in the face of a permanent decrease in demand for dollars, the Fed would have to continuously intervene in the foreign exchange market, which is unsustainable in the long term. This is because maintaining a fixed exchange rate against market forces requires constant adjustment of currency reserves and can conflict with other monetary policy goals.

Suppose the Target Exchange Rate Set by the Fed Is