Under the Exchange Rate Mechanism of the European Monetary System, when the British pound depreciated below its lower limit against the German mark, the German central bank was required to:

Question

BlackTom AI · Accepted Answer

When a currency hits its lower band, other central banks must intervene by buying the depreciating currency and selling their own currency to support its value.

1. Relevant knowledge points and concepts
- Exchange Rate Mechanism (ERM) set central parity and fluctuation bands; intervention was required when a rate reached the band limit.  
- Central-bank intervention: to prop up a depreciating currency, monetary authorities buy that currency on the FX market and sell their own currency.  
- International (foreign) reserves are holdings of foreign currencies by a central bank; buying foreign currency increases a central bank’s foreign reserves.

2. Step-by-step reasoning
- The pound has depreciated below its lower limit versus the German mark; the pound is therefore the depreciating currency.  
- To restore the agreed band, the pound must be purchased (demand increased) so its price rises back within the band.  
- The German central bank, under ERM obligations, would buy pounds on the FX market. To buy pounds it must sell marks (its domestic currency).  
- Buying pounds increases the German central bank’s holdings of a foreign currency (pounds), so its international (foreign) reserves rise.

3. Intermediate accounting steps (T-account style)
- Before: Assets include some foreign reserves; Liabilities include domestic currency in circulation.  
- Intervention: Assets: + pounds (foreign reserves); Liabilities or monetary base: - marks (sold). Net effect: foreign reserves increase.

4. Why the correct answer is correct
- Buying pounds and selling marks is the appropriate intervention to support a depreciating pound. Because pounds are a foreign asset for the Deutsche Bundesbank, acquiring them increases its international reserves.

5. Why the other options are incorrect
- (a) Buy marks and sell pounds would sell the depreciating currency (pound), worsening depreciation and would not align with support; also inconsistent with reserve effects.  
- (c) Buy pounds and sell marks, losing reserves contradicts accounting: buying foreign currency increases foreign reserves, not decreases them.  
- (d) Buy marks and sell pounds both misstates the intervention direction and the reserve effect.

6. Conclusion
The correct intervention is to buy pounds and sell marks, thereby gaining international reserves — matching answer b.

Under the Exchange Rate Mechanism of the European Monetary System, when the British pound depreciated below its lower limit against the German mark, the German central bank was required to:Single choice

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