Final answer:
It is true that to maintain a constant exchange rate, a government should match an increase in demand for its currency with a corresponding increase in supply. This can be achieved through central bank interventions, monetary policy adjustments, and the use of foreign currency reserves. Governments do this to manage currency value and meet certain economic goals.
Step-by-step explanation:
To address the question, it is True that to maintain a constant exchange rate, an increase in demand for a country's currency should be matched by a corresponding increase in supply; this management can indeed be administered by the government. Exchange rates represent the price of one country's currency in terms of another and are determined by supply and demand factors for that currency in the foreign exchange market.
When demand for a country's currency increases due to factors such as increased export activity or foreign investment, the value of the currency can rise unless the supply of the currency also increases to match the demand. To prevent this appreciation or a change in the exchange rate, a government with a fixed or pegged exchange rate regime will intervene in the forex market, often by using foreign currency reserves to buy its own currency and increase the supply, thus maintaining the exchange rate at a set level.
Moreover, governmental involvement in adjusting currency supply can be done through monetary policy actions, such as adjusting interest rates or through direct market intervention. If the central bank raises interest rates, it can curb domestic consumption and attract foreign capital, thus increasing demand for the currency without necessarily altering its supply. Conversely, if the bank lowers interest rates, it can discourage foreign investment, reducing the demand for the currency. Fiscal policies such as taxation and government spending can also impact currency supply and demand indirectly by affecting overall economic activity.
In a floating exchange rate system, a government might still intervene, but this is generally to smooth out volatility rather than to maintain a specific exchange rate target. The exact approach a government takes to maintain an exchange rate will vary, but the most direct method is the use of foreign currency reserves to maintain the desired balance between currency demand and supply.