Counteracting Increased Yuan Supply to Stabilize Exchange Rate Band

Steps:

• Supply shift from S1 to S2 increases Yuan supply in forex market, depreciating Yuan toward or below P1.
• Authorities must reduce Yuan supply or boost demand to defend the lower band P1.
• Capital outflows contribute to Yuan supply; restricting them limits depreciation pressure.
• Option A directly curbs outflows, stabilizing the rate within P1-P2.

Why A is correct:

• Capital controls reduce Chinese investment abroad, decreasing Yuan supply in forex markets and preventing depreciation below P1, per balance of payments theory.

Why the others are wrong:

• B: Lowers rates encourage outflows, increasing Yuan supply and worsening depreciation.
• C: Removing tariffs boosts US imports, raising Yuan supply for USD payments and pressuring rate down.
• D: Selling Yuan adds to supply, accelerating depreciation outside the band.

Final answer: A