-In the figure above, suppose the demand for dollars temporarily decreases so that the demand curve shifts to D₂. To maintain the target exchange rate, the Fed A) can sell dollars. B) can buy dollars. C) must violate both interest rate parity and purchasing power parity. D) cannot maintain the target exchange rate.

Question

Quizplus · Accepted Answer

When the demand for dollars decreases, the value of the dollar would naturally fall in a free market. To maintain the target exchange rate, the Fed can buy dollars, which reduces the supply of dollars in the foreign exchange market, supporting the dollar's value and keeping the exchange rate at its target.

-In the Figure Above, Suppose the Demand for Dollars Temporarily