Suppose that Econland has a fixed exchange-rate system. Econland's government (its central bank)will exchange as much local currency (say pesos)for foreign currency (say dollars)and as much foreign currency (say dollars)for local currency (say pesos)as is necessary to maintain the peg. Which of the following statements is not true?
A)Satisfying requests by people to get local pesos in exchange for foreign dollars is easy for the central bank to do.
B)The central bank has a restricted capacity to satisfy requests by people to get foreign dollars in exchange for local pesos.
C)Being the central bank, it has an equal capacity to satisfy requests to exchange dollars for pesos, and pesos for dollars.
D)The central bank needs to stockpile some foreign-exchange reserves in order to maintain the peg.

Question

Quizplus · Accepted Answer

The central bank has a potentially unlimited ability to create its own currency to exchange for foreign currency, making it easy to satisfy requests for local currency in exchange for foreign currency. However, its capacity to exchange local currency for foreign currency is limited by its foreign-exchange reserves. Therefore, it does not have an equal capacity to satisfy requests in both directions.

Suppose That Econland Has a Fixed Exchange-Rate System