Consider an economy with a fixed exchange rate and money supply equal to 2 billion pesos. The country has 1 billion in reserves and 1 billion in domestic credit. If there is a sudden decline in the demand for money, then:
A) the country needs to reduce its reserves to maintain the exchange rate.
B) the country needs to increase its reserves to maintain the exchange rate.
C) the country will face rising interest rates and, thus, a sharp appreciation of the peso.
D) the country will see a sharp increase in the demand for loans.

Question

Quizplus · Accepted Answer

When there is a decline in the demand for money, the central bank needs to buy back its currency to maintain the fixed exchange rate, which leads to a reduction in reserves.

Consider an Economy with a Fixed Exchange Rate and Money