Question

Suppose that the Chinese central bank has been intervening in the foreign exchange market, buying U.S. dollars in the market in an effort to keep its own currency, the yuan, weak. Use the model of demand and supply for dollars to show what the immediate effect would be on the yuan/dollar exchange rate of a decision by China to allow its currency to float freely.

Answer 1

If the Chinese Central bank stopped buying the US Dollar from the open market, on the demand graph, it will bend the demand curve of US dollar to the left, which in turn will bring about the fall in the quantity of the Yuan per dollar in equilibrium that the Yuan will appreciated against the US Dollar in the market.