Question

Under the Bretton-Woods system, if the market exchange rate E* is above the upper band of (par value +1%) against the $, what happens? (Notice: E* is to be intended as the price of foreign currency - for example, in the UK the market exchange rate with the US Dollar is 1$=BP E*)

4 Points

A.) No intervention by the Central Bank is needed

B.) The country is increasing its reserves of $ and can invest $ in T-Bills, or

exchange $ for gold at $35 per ounce
  c. The country is increasing its reserves of $ and can borrow $ from the IMF or exchange gold for $ with the US at $35 per ounce
d. The country is decreasing its reserves of $ and may borrow $ from the IMF or exchange gold for $ with the US at $35 per ounce

Answer 1

According to the information provided, the value of the exchange rate for British pound is going beyond the committed level of E*. This implies that British pound is getting depreciated against the dollar and the dollar is relatively appreciated. Central bank should act and start releasing dollar so as to increase its supply and depreciate it's appreciated value. This can be done by investing in government securities

Therefore B is correct.