If the central bank desires to purchase additional domestic bonds to stimulate the economy, then to maintain the peg, what must it do?
A) Decrease domestic spending.
B) Sell enough reserves to keep the interest rate unchanged.
C) Convince the public and investors that the peg is credible.
D) Immediately lower domestic rates of interest.

Question

Quizplus · Accepted Answer

If the central bank purchases additional domestic bonds to stimulate the economy, it will inject more money into the economy, which will increase the supply of money relative to the demand for it. This will reduce interest rates, which would typically cause the exchange rate to depreciate. To maintain the peg, the central bank will need to sell enough reserves to keep the interest rate unchanged. By selling reserves, the central bank can reduce the supply of money, which will offset the increase caused by the bond purchases and keep interest rates stable.

If the Central Bank Desires to Purchase Additional Domestic Bonds