Economics international finance Explain how foreign exchang

Economics ( international finance)

Explain how foreign exchange reserves are used to support a weak currency.

Solution

When a currency is weak (depreciated), the Central Bank uses foreign exchange reserves to strengthen it if required. This is done by the Central Bank by purchasing domestic currency in exchange of the foreign currency that it holds, which increases the demand for domestic currency and increases the supply of foreign currency. This appreciates and strengthens the domestic currency.