The diagram below shows the demand for foreign currency and the supply of foreign currency. The equilibrium exchange rate is e^*.

a. Suppose the Bank of Canada decides to fix the exchange rate at e₁. What must the Bank do to accomplish its goal? How do the Bank’s actions show up in the balance of payments accounts?

b. In part (a), explain why some people would call this a “a balance of payments surplus” even though the balance of payments is in balance.

c. Now suppose the Bank of Canada decides to fix the exchange rate at e₂. What must the Bank do to accomplish this goal? How do the Bank’s actions show up in the balance of payments accounts?

d. With the exchange rate fixed at e₂ , explain why some people would call this a “balance of payments deficit” even though the balance of payments is in balance.

Transcribed Image Text:

Exchange Rate e Units of Foreign Currency D S