How does a country that introduces a currency board make its commitment to converting its domestic currency on demand into another currency at a fixed exchange rate credible?
A) By borrowing funds from the International Monetary Fund and the World Bank
B) By maintaining a trade surplus with the foreign countries
C) By holding foreign currency reserves equal at the fixed exchange rate to at least 100 percent of the domestic currency issued
D) By importing more goods from foreign countries than it exports
E) By printing foreign currencies

Question

Quizplus · Accepted Answer

The country can make its commitment to convert its domestic currency on demand into another currency at a fixed exchange rate credible by holding foreign currency reserves equal at the fixed exchange rate to at least 100 percent of the domestic currency issued. This ensures that the country has enough foreign currency reserves to meet the demand for conversion and maintain the fixed exchange rate. Borrowing funds from international institutions, maintaining a trade surplus, importing more goods, or printing foreign currencies do not create the necessary credibility for the currency board.

How Does a Country That Introduces a Currency Board Make