3) In New Zealand, we currently have a floating exchange rate. However, this was not always the case. During most of the mid 20th century, New Zealand's exchange rate was fixed. Consider a situation where the central bank must keep the exchange rate fixed at a certain level.

a) During the outbreak of the Korean War in 1950, there was a large increase in demand for wool for stockpiles. As New Zealand exports a significant amount of wool, there was a large increase in demand for New Zealand's exports. How does the central bank respond when demand for the NZD increased in this situation in order to maintain the fixed exchange rate? Do they buy or sell NZD? Do they buy or sell foreign currency?

b) What are two advantages and two disadvantages of a fixed exchange rate?