Been pulling my hair over this question for Econs in the Qbank -
Developing country maintains fixed currency value relative to USD is experiencing decline in economic activity, and inflation falls below that of the US.
The most likely result of the developing country’s (ie. ABC) actions to maintain the fixed rate is: (Ans) that short term interest rates will fall…
the others were: foreign reserves will decrease (i chose this), money supply will contract
My reasoning for not choosing the correct option is as follows:
-economy & inflation drop = prices drop
-ABC weakens against USD
-must lower to keep target (ie. strengthen ABC’s currency)
-need to increase demand for ABC
-buy more ABC currency, sell foreign reserves
what was the mistake in my reasoning? i went onto various sites which said that to strengthen own currency, the central bank should buy it and sell foreign reserves… thanks!