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how exchange rate and inflation atomatically be changed?and what are the factors of chnging those things.
I am not sure what you mean by ‘automatically be changed’. Exchange rates change for all sorts of reasons – the relative rates of inflation in the two countries are just one factor. However we can forecast the effect of this one factor, which is why you have the formula on the formula sheet forecasting the exchange rate in terms of the inflation rates.
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will u plz explain this statment of purchasing power parity.that is .identical goods sell at the same price when converted into the same currency.
In a perfect world, if the current exchange rate were USD 2 = GBP 1, then something that cost GBP 100 in the UK would cost USD 200 in the US.
A year later, we say that both prices will have increased due to the inflation in each country – if inflation was 5% p.a. in the UK then the price will have gone up to GBP 105. If inflation was 8% in the US then the price there will have gone up to USD 216.
Purchasing power parity says that the exchange rate will have changed to that USD 216 converts to GBP 105.Obviously in real life, the same product does not sell at the same price in different countries for all sorts of other reasons. Similarly exchange rates change for all sorts of other reasons as well.
However, inflation is one factor that affects exchange rate, and purchasing power parity explains this factor.
sir thanks for ur ans,can i know how does exchange rates be influenced without having manipulation by govt (means naturally)?my quary is that we know govt stablishes most of the time the inflation rates and exchange rates,but how those things be influenced without manipulation?
With floating exchange rates (such as GBP, USD, EUR) the rate is really determined by supply and demand. If people think that (for example) the UK economy will do badly in the future, then they will sell out of GBP and the exchange rate will fall as a result.
But all of these floating exchange rates are managed floats and governments through their central banks intervene in the forex market using their foreign exchange reserves to stabilize the market and or support their currencies at different levels. The amount and frequency of intervention depends on both the country and the period of time you are looking at.
It should also be borne in mind that,especially in times of economic crisis,countries can and do introduce capital controls which directly restricts foreign currency dealings.Malaysia is an example of a country that introduced capital controls in late 90s following a financial crisis in the country and region. Also it should be borne in mind that even if a central bank attempts to support the level of its currency by using buying its own currency by using its foreign currency reserves or by increasing the base rate to attract capital inflows these attempts may be unsuccessful if the marketplace believes a currency is overvalued and they were unsuccessful when the British pound sterling was forced out of the Exchange Rate Mechanism in September 1992 despite attempts to support the currency.
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