Under a fixed exchange rate system with no private capital movements, how does the central bank respond to a balance of payments deficit?

Multiple choice question for Macroeconomic Issues and Analysis. Select an option, then review the explanation below.

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Purchase foreign currency and sell local currencySell foreign currency and purchase local currencyPurchase foreign currency and acquire local currencySell foreign currency and dispose of local currencyNone of the above

Explanation

When a country faces a balance of payments deficit under a fixed exchange rate regime without private capital flows, the central bank intervenes by selling its foreign currency reserves and buying domestic currency to maintain the fixed rate. This action reduces the supply of foreign currency and supports the local currency.

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Under a fixed exchange rate system with no private capital movements, how does the central bank respond to a balance of payments deficit?

Explanation

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