Question

Refer to the previous exercise. Which type of foreign market intervention must the central bank of Colombia conduct to keep the exchange rate at a level where the currency is not under- or overvalued in terms of PPP?

Short answer

The central bank of the Colombia should sell the Colombian pesos in the foreign exchange market to keep the exchange rate at a level where the currency is not under or over valued in terms of PPP.

Step-by-step solution

Concept Introduction 

Purchasing power parity (PPP) refers to the speculation that indicates the charge per unit of the 2 currencies from various countries is capable the ratio between their purchasing power.

Explanation of Solution  

The financial organization of the Colombia should sell the Colombian pesos within the interchange market to stay the charge per unit at tier where the currency isn't under or over valued in terms of PPP. because the currency is overvalued, the sale of the currency would increase the availability of the currency within the exchange market which might reduce its value because of excess supply and thanks to which rate level as per PPP may be achieved.

Thus, the financial organisation should sale the currency within the exchange market to realize the rate of exchange level as per the PPP.