Suppose that Econland adopts a ﬁxed exchange-rate system and pegs the value of its peso to the U.S. dollar. If people's demand for pesos increases in the foreign exchange markets, then
Econland's foreign-exchange reserves will
A) increase.
B) decrease.
C) stay the same.
D) equal the trade balance.

Question

Quizplus · Accepted Answer

If people's demand for pesos increases in the foreign exchange markets, Econland's foreign-exchange reserves will increase. This is because Econland's central bank will have to sell more dollars (which they use to purchase pesos) to meet the growing demand, and in doing so, they will accumulate more foreign-exchange reserves.

Suppose That Econland Adopts a ﬁXed Exchange-Rate System and Pegs