Citizens in the United States increase their demand for impo

Citizens in the United States increase their demand for imported goods. This will cause the dollar to __________. To maintain the initial exchange rate the Fed should __________.

appreciate; sell foreign reserves

depreciate; buy foreign reserves

appreciate; buy foreign reserves

depreciate; sell foreign reserves

Solution

Ans. depreciate;sell foreign currency.

If there is a increase in the demand for imports the country\'s demand for the domestic goods falls and there will be an increase in the foreign products. So the aggregate demand in the country goes down. The increase in the demand for the imports will depreciate the home currency because of the increased demand for the foreign currency from the domestic consumers. To maintain the initial exchange rate the Fed should sell the foreign reserve to buy the dollars, so now there is an increase in the demand for the dollars which will bring back the exchange rate to its original position.