IB International Economics Higher Level (HL) Practice Exam

In a fixed exchange rate system, a central bank maintains the value of its currency at a fixed rate relative to another currency, usually by intervening in the foreign exchange market. To revalue a currency means that the central bank increases the value of the currency in terms of the foreign currency it is pegged to. Choosing to buy the domestic currency using foreign exchange reserves is the necessary action for revaluation. When the central bank purchases its own currency, it reduces the supply of that currency available in the market. This reduction in supply leads to an appreciation of the currency's value, effectively raising its exchange rate relative to the foreign currency. This action contrasts with simply selling foreign exchange reserves, which is typically done to devalue a currency by increasing its supply in the market. Reducing interest rates can also make a currency less attractive to foreign investors, leading to depreciation rather than revaluation. Thus, buying currency using foreign exchange reserves is the appropriate action to revalue a currency in a fixed exchange rate regime.