ACCA Applied Knowledge · Business and Technology · Macroeconomic factors
A country operates a floating exchange rate system. Its central bank is concerned that rising demand for its currency from foreign investors is pushing up the exchange rate and hurting exporters. Which action would the central bank most plausibly take to reduce the upward pressure?
The central bank would cut interest rates. Lower rates make holding the currency less attractive to foreign investors, reducing demand for it and easing the exchange rate. Raising rates would attract more capital and strengthen the currency further, and an import quota would not weaken it.
- ARaise interest rates to attract further foreign capital
- BCut interest rates, making holding the currency less attractive to foreign investorsCorrect
- CImpose a quota on imports to reduce the supply of the currency
Explanation
Lower interest rates reduce the return on assets in the currency, so foreign demand for it falls and the exchange rate eases. Raising rates would increase demand and push the rate higher still. A quota on imports reduces the supply of the currency sold to buy foreign goods, which would tend to strengthen it, not weaken it.
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