Under a fixed exchange rate system, the government bears the responsibility to ensure that the BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves. If the sum of the first two accounts is GREATER THAN ZERO, a ________ demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervene in the foreign exchange market and ________ domestic currency for foreign currencies or gold so as to bring the BOP back near zero.
A) surplus; sell
B) surplus; buy
C) deficit; sell
D) deficit; buy

Question

Quizplus · Accepted Answer

When the sum of the current and capital accounts is greater than zero, it indicates a surplus in the balance of payments, suggesting a higher demand for the domestic currency. To maintain the fixed exchange rate and balance the BOP, the government needs to sell domestic currency in exchange for foreign currencies or gold.

Under a Fixed Exchange Rate System, the Government Bears the Responsibility