If the central bank (such as the fed in the us) of a country is steadily losing

Question

If the central bank (such as the fed in the us) of a country is steadily losing their foreign exchange reserves under a fixed exchange rates, then probably
A. Its currency is overvalued B. Its currency is undervalued C. It has a high interest rate D. It has a balance of pmts surplus If the central bank (such as the fed in the us) of a country is steadily losing their foreign exchange reserves under a fixed exchange rates, then probably
A. Its currency is overvalued B. Its currency is undervalued C. It has a high interest rate D. It has a balance of pmts surplus
A. Its currency is overvalued B. Its currency is undervalued C. It has a high interest rate D. It has a balance of pmts surplus

Explanation / Answer

Correct option (B).

Under a fixed exchange rate system, central bank uses its forex reserves to keep the exchange rate within the limit it desires. If the exchange rate goes much higher than the fixed rate, it means that the foreign currency's value has increased vis-a-vis domestic currency (that is, if domestic currency becomes undervalued), the central bank will sell its doreign currency reserve to reduce the pressure on foreign currency so that its domestic currency can come back to the required balance.

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