Refer to the figure below to answer the following questions.

Figure 25.3.1
-In Figure 25.3.1, suppose the demand for dollars temporarily decreases so that the demand curve shifts to D₂. To maintain the target exchange rate, the Bank of Canada
A)sells dollars.
B)buys dollars.
C)must violate both interest rate parity and purchasing power parity.
D)must raise the target exchange rate.
E)must lower the target exchange rate.

Question

Refer to the figure below to answer the following questions.
  
Figure 25.3.1
-In Figure 25.3.1, suppose the demand for dollars temporarily decreases so that the demand curve shifts to D₂. To maintain the target exchange rate, the Bank of Canada
A)sells dollars. 
B)buys dollars. 
C)must violate both interest rate parity and purchasing power parity. 
D)must raise the target exchange rate. 
E)must lower the target exchange rate.

Quizplus · Accepted Answer

When the demand for dollars decreases, the exchange rate will be lower than the target rate set by the Bank of Canada. To maintain the target rate, the Bank of Canada needs to increase the demand for dollars by buying them in the foreign exchange market. Therefore, the correct answer is B, which states that the Bank of Canada buys dollars. The other choices are incorrect because there is no mention of interest rate parity or purchasing power parity being violated, and there is no need to raise or lower the target exchange rate.

Refer to the Figure Below to Answer the Following Questions