What are the consequences for a nation that keeps its exchange rate fixed, holds its own domestic interest rates below market to encourage domestic spending, and allows free foreign investment?
A) Foreign investors will not invest, so the only consequence will be a decline in the inflow of foreign investment.
B) Domestic and foreign investors will invest in other nations, causing a sell-off of the domestic currency and, to maintain fixed rates, the central bank will have to buy its own currency, depleting its treasury reserves.
C) There will be upward pressure on the rate of interest as more borrowing occurs, so the central bank will have to increase the stock of money.
D) Interest rates in other nations will also fall as banks and other firms have to compete for international borrowers.

Question

Quizplus · Accepted Answer

By keeping the exchange rate fixed and holding domestic interest rates below market, there will be increased demand for domestic goods and services, leading to higher spending. However, allowing free foreign investment means there will be a high supply of domestic currency in the foreign exchange market, causing the currency to depreciate. This will lead to a sell-off of the domestic currency by both domestic and foreign investors. To maintain the fixed exchange rate, the central bank will have to buy its own currency, depleting its treasury reserves.

What Are the Consequences for a Nation That Keeps Its