Central banks control exchange rates by intervention. If a nation such as Japan wished to peg its market rate at a certain level, such as ¥100 = $1, what should it do if the actual market rate begins to depreciate to ¥125 = $1?
A) It should purchase dollars with its own currency.
B) It should sell dollars from its treasury and retire its own currency.
C) It should increase its GDP to increase exports.
D) It should petition the IMF for a rate change.

Question

Quizplus · Accepted Answer

To maintain or peg the exchange rate at ¥100 = $1, when the actual market rate depreciates to ¥125 = $1, the central bank (in this case, Japan's) should sell dollars from its treasury and buy back its own currency (yen). This action reduces the supply of yen in the market, increasing its value back towards the desired pegged rate.

Central Banks Control Exchange Rates by Intervention