FIGURE 13-7: How a Fixed Exchange Rate Governs the Money Supply In panel (a), the equilibrium exchange rate initially exceeds the fixed level. Arbitrageurs will buy foreign currency in foreign-exchange markets and sell it to the Fed for a profit. This process automatically increases the money supply, shifting the LM* curve to the right and lowering the exchange rate. In panel (b), the equilibrium exchange rate is initially below the fixed level. Arbitrageurs will buy foreign currency from the Fed and sell it in foreign-exchange markets for a profit. This process automatically reduces the money supply, shifting the LM* curve to the left and raising the exchange rate.