When a nation is maintaining an exchange rate peg, its money supply is typically backed by:
A) gold.
B) nothing.
C) domestic bonds and foreign exchange assets purchased with the national currency.
D) domestic credit only.

Question

Quizplus · Accepted Answer

When a nation is maintaining an exchange rate peg, its money supply is typically backed by domestic bonds and foreign exchange assets purchased with the national currency. This is because in order to maintain the fixed exchange rate, the central bank of the country must intervene in the foreign exchange market by buying and selling its own currency in exchange for foreign currencies. To do this, it needs to have reserves of foreign currency, which are typically acquired by purchasing foreign exchange assets with the national currency. Additionally, the central bank may also issue domestic bonds to absorb excess liquidity in the money supply and help support the exchange rate peg. Unlike a gold standard, the currency is not backed by a physical commodity but by assets held by the central bank.

When a Nation Is Maintaining an Exchange Rate Peg, Its