Suppose the Bank of Canada follows a fixed-exchange rate of 0.50 U.K. pounds per Canadian dollar. If the demand for dollars temporarily decreases, to maintain the target exchange rate, the Bank can
A)sell dollars.
B)buy dollars.
C)increase Canadian exports.
D)increase Canadian imports.
E)violate purchasing power parity.

Question

Quizplus · Accepted Answer

If the demand for dollars decreases, the supply of Canadian dollars in the foreign exchange market will increase, which will lead to a depreciation of the Canadian dollar. To maintain the fixed-exchange rate of 0.50 U.K. pounds per Canadian dollar, the Bank of Canada will have to buy Canadian dollars and sell U.K. pounds. This will increase the demand for Canadian dollars in the foreign exchange market and prevent a depreciation of the Canadian dollar. Therefore, option B is the best choice.

Suppose the Bank of Canada Follows a Fixed-Exchange Rate of 0.50