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

When demand for pesos increases under a fixed exchange-rate system, Econland's central bank must sell pesos and buy foreign currency (in this case, U.S. dollars) to maintain the peg. This action increases Econland's foreign-exchange reserves.

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