Use the following graph, which shows the supply and demand for British pounds, t

Question

Use the following graph, which shows the supply and demand for British pounds, to answer the next question.

D1 and S1 represent the initial demand and supply curves. If the supply of British pounds in the foreign exchange market shifts to S3, and the British government wants to fix the exchange rate at its initial level, then it should

Multiple Choice

sell U.S. dollars out of its reserves.

buy U.S. dollars to add to its reserves.

sell British pounds in the foreign exchange market.

buy British bonds in the open market.

Explanation / Answer

It will sell US dollars out of its reserves. It will decrease the supply of pounds and parallely Increasing the supply of dollar which will lead to appreciation of British Pound.

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