Question

If the Federal Reserve buys dollars in the foreign exchange market but conducts an offsetting open market operation to sterilize the intervention, what will be the impact on international reserves, the money supply, and the exchange rate?

Short answer

The effect of the sale of dollars in the exchange market by the Fed would increase the international reserves, finances but would decrease the rate of exchange.

Step-by-step solution

Concept Introduction

Interchange market refers to the market where the exchange of currencies takes place. it's an area where one can trade for the currencies and thru which the availability and demand of a currency is decided and also determines the exchange rate of that currency.

Explanation of Solution

The effect of the sale of dollars in the exchange market by the Fed would increase the international reserves, finances but would decrease the rate of exchange. because the government has conducted the offsetting open market operation, it'll decrease the international reserves, cash in hand and would increase the charge per unit and ending would be same as before. So, there would be no major change within the international reserves, cash in hand and rate of exchange because of offsetting open market operations. Thus, the effect on the inner reserves, on monetary resources and on the rate of exchange would remain the same under the given situation.