Assume that a country is running a net credit balance on the balance of payments (BOP) and that the country is trying to maintain a fixed exchange rate against the currencies of its major trading partner. Under these conditions, which of the following statements is incorrect?
A) The country is required to intervene in the market to buy up the excess foreign currency.
B) The country is required to intervene in the market to supply foreign currencies from reserves.
C) The country will have to make changes in its domestic economy, most likely to lower interest rates, to increase demand for imports.
D) The country will have to make changes in its domestic economy, most likely to raise interest rates, to decrease demand for imports.
E) Statements b and d are incorrect.

Question

Quizplus · Accepted Answer

A net credit balance on the BOP indicates that the country is exporting more than it is importing, leading to an inflow of foreign currency. To maintain a fixed exchange rate, the country would buy up the excess foreign currency (A), not supply more from its reserves (B). Lowering interest rates (C) could increase import demand, balancing the BOP, while raising interest rates (D) would decrease import demand and increase the credit balance, contrary to the goal of balancing the BOP. Therefore, statements B and D are incorrect.

Assume That a Country Is Running a Net Credit Balance