Q2 If the Federal Reserve buys doll... [FREE SOLUTION]

Chapter 19: Q2 (page 527)

If the Federal Reserve buys dollars in the foreign exchange market but does not sterilize the intervention, what will be the impact on international reserves, the money supply, and the exchange rate?

Short Answer

Expert verified

The international reserves would decrease, the money supply would decrease, and also the rate of exchange would increase under the given situation. because the government doesn't sterilize the intervention, the acquisition of dollars by the govt in interchange market would be possible with the exchange of the international reserves.

Step by step solution

Concept Introduction

Foreign exchange market refers to the market where the exchange of currencies takes place. it's an area where one can trade for the currencies and through which the provision and demand of a currency are determined and determines the interchange rate of that currency.

Explanation of Solution

So, the rise of dollars through purchase would decrease the international reserves. Similarly, purchase of dollars by the govt would scale back the quantity of dollars within the foreign market which might reduce the money supply for the dollar within the exchange market. So, the acquisition of dollar by the govt would decrease the money supply of the dollar. Purchase of dollar and reduced market supply would increase the demand for the dollar and therefore the increased demand would increase the worth of the dollar that may increase its charge per unit. So, purchase of dollars by the govt. would increase the rate of exchange for the dollar.

Thus, international reserves would decrease, the money supply would decrease, and also the charge per unit would increase under the given situation.