Chapter 18, Problem 1Q

To determine

The effect on international reserves, on the money supply and on the exchange rate when Federal Reserve sells dollars in the foreign exchange market but conducts an offsetting open market operation to sterilize the intervention.

Explanation of Solution

The effect of the sale of dollars in foreign exchange market by Federal Reserve would increase the international reserves, money supply but would decrease the exchange rate. As the government has conducted the offsetting open market operation, it will decrease the international reserves, money supply and would increase the exchange rate and end result would be same as before. So, there would be no major change in the international reserves, money supply and exchange rate due to offsetting open market operations.

Thus, the effect on the internal reserves, on money supply and on the exchange rate would remain same under given situation.

Economics Concept Introduction

Introduction: Foreign exchange market refers to the market where the exchange of currencies takes place. It is a place where one can trade for the currencies and through which the supply and demand of a currency is determined and also determines the foreign exchange rate of that currency.