Using the central bank balance sheet diagrams, evaluate how each of the following shocks affects a country’s ability to defend a fixed exchange rate. In the following answers, we assume the central bank keeps domestic credit unchanged whenever possible. See the following graphs.
a. The central bank buys government bonds.
b. Currency traders expect an appreciation in the home currency in the future.
c. An economic expansion leads to a change in home money demand.
d. The foreign interest rate increases.