Explain and demonstrate graphically the situation of an overvalued exchange rate in a fixed exchange rate system. What alternative policies are available to eliminate the overvaluation of the exchange rate?
What will be an ideal response?
See the figure below.
The par value is above the equilibrium value, resulting in overvaluation of the exchange rate. One approach is to pursue contractionary monetary policies, raising interest rates and increasing the demand for domestic assets. This process continues until equilibrium at par value is restored. Another alternative is for the central bank to purchase domestic currency by selling foreign assets.
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In the above figure, at the equilibrium price and quantity, consumer surplus is ________
A) $90 B) $60 C) $45 D) $30
If a country's private saving is 100 and government saving is -100, domestic private investment
A) must be 200. B) must be zero. C) is equal to the net amount the economy borrows from other countries. D) is equal to the net amount the economy lends to other countries.