Question

Explain how the government maintains the value of its currency fixed with a foreign currency through buying and selling of reserves.

Answer 1

Answer - In the fixed exchange rate system , if the government wants to invrease the value of domestic currency , it will buy back the domestic currency from the world and sell out the foreign reserves. This will create additional demand for domestic currency in world market and value will increase. On the other hand , in the process of devaluation , the government will buy the foreign reserves from world market and sell of domestic currency. This will lead to the devaluation of domestic currency