Cfa level 1 : economics

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Cfa level 1 : economics

Postby mehak.officiallink » Tue Nov 18, 2014 7:16 pm

If the foreign exchange value of domestic currency falls relative to the US dollar, the monetary authority must use foreign reserves to purchase their domestic currency in order to reach target exchange rate. Please explain how is the target exchange rate reached ? Not able to understand this line...

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Cfa level 1 : economics

Postby edupristine » Thu Nov 27, 2014 6:08 am

Because if domestic currency falls (=depreciation) and the central bank does not want it to depreciate, it needs to buy back its domestic currency (law of supply of demand here, shifting demand will increase prices ceteris paribus), and to do so, it’ll “spend” its foreign reserves. Unfortunately, foreign reserves are scarce and this policy has its limits.

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