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 LESS 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

If the sum of the current and capital accounts is less than zero, it indicates a deficit demand for the domestic currency. To maintain the fixed exchange rate, the government needs to buy domestic currency using its reserves of foreign currencies or gold, thereby increasing the demand for the domestic currency and helping to balance the BOP.

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