The figure given below depicts the equilibrium in the foreign exchange market. Figure 13.1 -Refer to Figure 13.1. If the current equilibrium exchange rate is E₁ what action would the Fed have to take to achieve a target exchange rate of E₂? A) Sell (Q₂ - Q₁) amount of U.S. dollars. B) Buy (Q₁ - Q₃) amount of U.S. dollars. C) Buy (Q₂ - Q₃) amount of U.S. dollars. D) Buy (Q₂ - Q₁) amount of U.S. dollars. E) Sell (Q₁ - Q₃) amount of U.S. dollars.

Question

Quizplus · Accepted Answer

To achieve a higher target exchange rate of E₂, the Fed needs to increase the demand for U.S. dollars in the foreign exchange market. This can be done by buying U.S. dollars, which would increase the supply of foreign currency and decrease the supply of U.S. dollars. As a result, the exchange rate would increase to E₂. Therefore, the Fed would need to buy (Q₂ - Q₁) amount of U.S. dollars.

The Figure Given Below Depicts the Equilibrium in the Foreign