The figure given below depicts the foreign exchange market for British pounds traded for U.S. dollars.Figure 22.2 -Refer to Figure 22.2. Suppose the British central bank is committed to maintaining an exchange rate of £1 = $1.50, but there is a permanent shift in supply from S₁ to S₃. According to the Bretton Woods agreement: A)the pound should be devalued. B)the dollar should be devalued. C)the British central bank should buy pounds in exchange for dollars. D)the British central bank should encourage speculation. E)the Fed should intervene to maintain the exchange rate of £1 = $1.

Question

Quizplus · Accepted Answer

According to the Bretton Woods agreement, the British central bank is committed to maintaining a fixed exchange rate of £1 = $1.50. However, with a permanent shift in supply from S₁ to S₃, the demand for pounds decreases, causing a decrease in the value of the pound relative to the dollar. To maintain the fixed exchange rate, the British central bank should devalue the pound by allowing it to float freely or by buying dollars in exchange for pounds to increase the demand for pounds and increase their value. Therefore, option A is the correct answer.

The Figure Given Below Depicts the Foreign Exchange Market for British