Central Bank Sells Currency to Depreciate and Peg Exchange Rate

Steps:

• Identify equilibrium: Intersection of D and S curves determines market price above P1, creating excess demand at P1.
• Assess imbalance at P1: Demand exceeds supply by quantity XY, as quantity demanded > quantity supplied.
• Determine intervention: To peg at P1 (below equilibrium), central bank increases supply by selling yuan to satisfy excess demand.
• Calculate amount: Sell exactly XY yuan to shift effective supply rightward, clearing the market at P1.

Why B is correct:

• Selling XY yuan eliminates excess demand at P1, per central bank sterilization in forex markets to enforce pegs below equilibrium.

Why the others are wrong:

• A: Buying yuan reduces supply, raising price above P1, worsening appreciation pressure.
• C: Selling XZ yuan (larger quantity) oversupplies, driving price below P1 unintentionally.
• D: Buying XZ yuan (even larger) aggressively appreciates yuan far above P1.

Final answer: B