Effects of Central Bank Intervention
a. Assume that the Federal Reserve engages in intervention by exchanging a very large amount of Canadian dollars for U.S. dollars in the foreign exchange market. Should this increase, reduce, or have no effect on Canadian inflation? Briefly explain.
b. Ignore the actions of the Federal Reserve in the question above and assume that the Canadian central bank raises its interest rates. Should this increase, reduce, or have no effect on Canadian inflation? Briefly explain.
c. The Hong Kong dollar is tied to the U.S. dollar and will continue to be tied to the dollar. Given your answer in part (a), how will the intervention by the Federal Reserve affect the cross exchange rate between the Canadian dollar and the Hong Kong dollar?