The main difficulty with a fixed or pegged exchange rate regime is that the:
A)government finds it difficult to conduct fiscal policy as it cannot always be certain of the central bank's intervention in foreign exchange markets.
B)central bank must always sterilise foreign exchange market interventions.
C)central bank loses the power to conduct independent domestic monetary policy.
D)central bank will run out of official reserves of foreign exchange.

Question

Quizplus · Accepted Answer

With a fixed or pegged exchange rate regime, the central bank must maintain the exchange rate at the fixed level, which means that it cannot independently conduct domestic monetary policy. This can lead to conflicts between the government's desire for economic growth and the central bank's responsibility for maintaining the exchange rate. As a result, a fixed or pegged exchange rate regime can limit the effectiveness of domestic economic policies.

The Main Difficulty with a Fixed or Pegged Exchange Rate