Under a fixed exchange rate system, when total outflows of foreign exchange exceed total inflows of foreign exchange at the current fixed exchange rate:
A) the central bank would buy foreign exchange causing the economy to contract.
B) the central bank would sell foreign exchange causing the economy to contract.
C) the central bank would buy foreign exchange causing the economy to expand.
D) the central bank would sell foreign exchange causing the economy to expand.
E) the central bank would sell foreign exchange and cause the price level to fall.

Question

Quizplus · Accepted Answer

Under a fixed exchange rate system, when outflows of foreign exchange exceed inflows, the central bank must sell foreign exchange reserves to maintain the fixed rate. This action reduces the money supply, which can lead to a contraction in the economy.

Under a Fixed Exchange Rate System, When Total Outflows of Foreign