Question

Hong Kong fixes its currency, the HK$ (actually it pegs it to the US$)

If the HK$ would otherwise depreciate in a floating exchange rate regime, what could the Hong Kong central bank do to maintain the fix?

A.) Reduce import tariffs on U.S.-made goods

B.) Sell US$ reserves

C.) Sell more HK$

D.) Buy more US$

explain

Answer 1

C. Sell more HK $

As the Hong Kong Central bank sells more HK$, the money supply of HK$ increases in the market, this leads to increase in interest rates( cost of borrowing). When there is increase in interest rates, private investment and consumption expenditure decreases, this results in fall in Aggregate demand( AD) curve in the market. Fall in AD curve leads to reduction  in Inflation. Therefore the currency value appreciates.