Under a fixed exchange rate system,a real interest rate corresponding to the upward-sloping portion of the NCF curve reflects the fact that a central bank ________,and the real interest rate corresponding to the horizontal portion of the NCF curve reflects the fact that a central bank ________.
A) can always supply more domestic currency; can always meet the demand for foreign currency
B) can always supply more domestic currency; is limited in meeting the demand for foreign currency
C) is limited in meeting the demand for domestic currency; can always meet the demand for foreign currency
D) is limited in meeting the demand for domestic currency; is limited in meeting the demand for foreign currency

Question

Quizplus · Accepted Answer

Under a fixed exchange rate system, the central bank has to intervene in the foreign exchange market to maintain the fixed exchange rate. If the demand for foreign currency increases, the central bank has to supply more domestic currency to purchase foreign currency and maintain the fixed exchange rate. This implies that the real interest rate corresponding to the upward-sloping portion of the NCF curve reflects the fact that the central bank can always supply more domestic currency. However, if the demand for foreign currency exceeds the central bank's ability to supply more domestic currency, the central bank may run out of foreign reserves, leading to a potential devaluation of the domestic currency. This implies that the real interest rate corresponding to the horizontal portion of the NCF curve reflects the fact that the central bank is limited in meeting the demand for foreign currency. Therefore, option B is the best choice.

Under a Fixed Exchange Rate System,a Real Interest Rate Corresponding