The figure given below depicts the foreign exchange market for British pounds traded for U.S.dollars. Figure 22.2 - Refer to Figure 22.2.Suppose the British central bank is committed to maintaining an exchange rate of £1 = $1.50,but there is a permanent shift in supply from S₁ to S₃.According to the Bretton Woods agreement: A)the pound should be devalued. B)the dollar should be devalued. C)the British central bank should buy pounds in exchange for dollars. D)the British central bank should encourage speculation. E)the Fed should intervene to maintain the exchange rate of £1 = $1.

Question

Quizplus · Accepted Answer

The permanent shift in supply from S₁ to S₃ implies that the supply of pounds has increased while the demand for pounds has remained the same. This will result in a surplus of pounds in the market which will put downward pressure on the exchange rate. To maintain the exchange rate of £1 = $1.50, the British central bank will need to buy pounds in exchange for dollars. However, this would lead to a depletion of the British central bank's foreign exchange reserves. Therefore, in the Bretton Woods agreement, the country was allowed to devalue its currency if it faced a persistent balance of payment deficit. Therefore, the pound should be devalued to maintain the exchange rate of £1 = $1.50.

The Figure Given Below Depicts the Foreign Exchange Market for British