Under a system of fixed exchange rates,a balance-of-payments deficit means that a country's currency is
A) partially valued.
B) undervalued.
C) overvalued.
D) devalued.
E) revalued.

Question

Quizplus · Accepted Answer

Under a fixed exchange rate system, the value of a country's currency is fixed in relation to another currency or a basket of currencies. If a country experiences a balance-of-payments deficit (i.e. it imports more than it exports), it will be forced to use its foreign exchange reserves to pay for the difference. This, in turn, reduces the supply of its currency in the foreign exchange market, which should increase its value. However, since the exchange rate is fixed, the country cannot allow its currency to appreciate. This means that the currency is overvalued relative to what it would be in a floating exchange rate system.

Under a System of Fixed Exchange Rates,a Balance-Of-Payments Deficit Means