To maintain a pegged rate, a nation faces a trilemma and must also:
A) generate extra export revenues.
B) watch carefully to ensure imports and exports are equal.
C) adjust its interest rates and money supply to ensure the home interest rate is equal to the foreign interest rate to prevent pressure on the exchange rate.
D) restrict foreign capital inflows and domestic capital outflows.

Question

Quizplus · Accepted Answer

To maintain a pegged rate, the nation must adjust its interest rates and money supply to ensure the home interest rate is equal to the foreign interest rate to prevent pressure on the exchange rate. This is known as the interest rate trilemma, which states that a country cannot have a fixed exchange rate, free capital movement, and an independent monetary policy all at the same time. If a country tries to have all three, it will face pressure on its exchange rate. Therefore, it is necessary to adjust the interest rates and money supply to maintain the pegged rate. Generating extra export revenues and watching import/export levels are not directly related to maintaining a pegged rate, and restricting capital flows would only be applicable in certain situations.

To Maintain a Pegged Rate, a Nation Faces a Trilemma