Fixed Exchange Rates

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government acting through the central bank, agrees
to buy or sell as much of the currency people wish to trade at the fixed
exchange rate. Most central banks act as the government's banker, the
Banks' bank, lender of last resort and issuer of notes as well as
supervising the banking system and operating monetary policy. Monetary
policy refers to the attempts to manipulate the interest rate and the money
supply so as to bring about desired changes in the economy. The aims of
monetary policy are the same as those of economic policy generally. They
are the maintenance of full employment, price stability, a satisfactory
rate of economic growth, and a balance of payments equilibrium.

Under a fixed exchange rate regime, governments are committed to
intervention in the foreign exchange market to maintain a given nominal
exchange rate. It is important by the central bank to intervene in order
to buy or sell the foreign exchange in the open market economy. It is
very ...

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rate to appreciate, and forcing the central bank to
intervene to hold the exchange rate constant. It buys the foreign money,
in exchange for domestic money. This intervention takes place until the
interest rates are back in line with those in the world market. When price
adjustment is slow, an increase in the nominal money supply increases the
real money supply in the short run, and tends to reduce domestic interest
rates. With perfect capital mobility, this leads to a capital account
outflow until the domestic money supply has been reduced to its original
level and interest rates have returned to world levels. Hence domestic
policy is powerless in a fixed exchange rate ...

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