Suppose the government is faced with a continual excess demand for foreign exchange.Which of the following strategies would the government choose to pursue in order to eliminate the disequilibrium situation?

Question

Quizplus · Accepted Answer

The government would either increase the peg (if they have a fixed exchange rate system) or devalue (if they have a flexible exchange rate system) in order to make the domestic currency less expensive relative to foreign currencies. This would incentivize more people to buy domestic goods and services, which would increase the supply of domestic currency and decrease the demand for foreign currency, thus eliminating the excess demand for foreign exchange. Engaging in fiscal or monetary policy or increasing inflation rate would not directly address the excess demand for foreign exchange.

Suppose the Government Is Faced with a Continual Excess Demand