page_title: Fixed exchange rate system
section_title: Excess supply of dollars
hierarchical_section_title: Fixed exchange rate system / Open market mechanism example / Excess supply of dollars
caption_attribution_description: English: Excess Supply of Dollars
context_page_description: A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold.
  There are benefits and risks to using a fixed exchange rate system. A fixed exchange rate is typically used to stabilize the exchange rate of a currency by directly fixing its value in a predetermined ratio to a different, more stable, or more internationally prevalent currency to which the currency is pegged. In doing so, the exchange rate between the currency and its peg does not change based on market conditions, unlike in a floating exchange regime. This makes trade and investments between the two currency areas easier and more predictable and is especially useful for small economies that borrow primarily in foreign currency and in which external trade forms a large part of their GDP.
  A fixed exchange rate system can also be used to control the behavior of a currency, such as by limiting rates of inflation. However, in doing so, the pegged currency is then controlled by its reference value.
context_section_description: Fig.3 describes the excess supply of dollars. This is a situation where the foreign demand for goods, services, and financial assets from the European Union exceeds the European demand for foreign goods, services, and financial assets. If the supply of dollars rises from SS to S'S', excess supply is created to the extent of ab. The ECB will buy ab dollars in exchange for euros to maintain the limit within the band. Under a floating exchange rate system, equilibrium would again have been achieved at e.
  When the ECB buys dollars in this manner, its official dollar reserves increase and domestic money supply expands, which may lead to inflation. To prevent this, the ECB may sell government bonds and thus counter the rise in money supply.
  When the ECB starts accumulating excess reserves, it may also revalue the euro in order to reduce the excess supply of dollars, i.e., narrow the gap between the equilibrium and fixed rates. This is the opposite of devaluation.
caption: Fig.3: Excess supply of dollars
exif: {}