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Chapter 6

Q. 6.ST.1

Explain why it would be virtually impossible to set an exchange rate between the Japanese yen and the U.S. dollar and to maintain a fixed exchange rate.


Verified Solution

Market forces cause the demand and supply of yen in the foreign exchange market to change, which causes a change in the equilibrium exchange rate. The central banks could intervene to affect the demand or supply conditions in the foreign exchange market, but they would not always be able to offset the changing market forces. For example, if there were a large increase in the U.S. demand for yen and no increase in the supply of yen for sale, the central banks would have to increase the supply of yen in the foreign exchange market to offset the increased demand.