Under the ERM of the EMS, when the British pound depreciated below its limit vs. the German mark, the Bank of England had to:

Question

BlackTom AI · Accepted Answer

When a currency falls below its permitted lower band (depreciates), the central bank must create demand for that domestic currency to stop further depreciation. Under the ERM, that meant the Bank of England intervened by buying pounds and supplying foreign currency (German marks).

Relevant concepts:
- Fixed/pegged exchange-rate bands: central banks commit to defend a central parity by intervening in FX markets within set limits.
- Intervention mechanics: to support a depreciating domestic currency, the central bank buys domestic currency and sells foreign reserves.
- Reserve effects: selling foreign currency reserves (marks) reduces official reserves.

Step‑by‑step reasoning:
1. The pound depreciates versus the German mark — market pressure is excess supply of pounds and excess demand for marks.
2. To reverse this, the Bank of England must increase demand for pounds and reduce supply of marks in the FX market.
3. Practically the BoE offers to buy pounds from market participants and pays with marks (i.e., it sells marks).
4. Each purchase of pounds uses up the BoE’s stock of marks (foreign exchange reserves), so official reserves fall.
5. This intervention raises the pound’s value back toward the lower band by reducing pound supply and increasing pound demand.

Why the correct choice is correct:
- “Buy pounds, sell marks” is exactly the operation needed to support a depreciating pound.
- “Losing reserves” follows because selling marks reduces the Bank’s foreign currency holdings.

Why other options are incorrect:
- Options a and d (buy marks, sell pounds) describe intervention to counter an appreciation of the pound (not a depreciation).
- Options c and d claim “gaining reserves,” but selling marks to buy pounds depletes, not increases, reserves.

Conclusion: The correct action is b. buy pounds, sell marks, losing reserves, which matches the provided answer.

Under the ERM of the EMS, when the British pound depreciated below its limit vs. the German mark, the Bank of England had to:Single choice

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