The Danish central bank is committed to maintaining a fixed exchange rate of 7.46 Danish krone per euro, with a band of 2.25 percent on each side of this central rate.

Under current conditions in the foreign exchange market, nonofficial supply and demand would intersect at a rate of about 7.1 krone per euro. The Danish central bank has sufficient international reserve assets and uses official intervention to defend the fixed rate.

a. Draw a demand and supply graph of the foreign exchange market showing the central rate (7.46 krone per euro) and the positions of the nonofficial supply and demand curves.

b. As a result of the official intervention, what will be the change in Denmark’s holdings of international reserves? In your explanation, refer to your graph.

c. If the Danish central bank does not sterilize its intervention, will the Danish money supply tend to increase, stay the same, or decrease? Why?