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Sir, when we are talking in the context of purchasing, a high level of inflation in an economy, relative to the inflation rates overseas will result in a depreciation of the currency. As a result of the currency fluctuation imports will cost more but it may be easier to export since goods will appear cheaper to overseas purchasers.
However when we talk about macroeconomic policy of controlling inflation: if a country has a higher rate of inflation than its major trading partners, its exports will become relatively expensive
So in the first context it is exports compared to companys own cost of exports previously? so that’s becoming expensive?
but in the second context it is exports as compared to other exporters?
kindly help me understand sir…..
Ive got the same question with interest rates…. high interest rates in domestic country mean lower forward rate and we usually assume that fwd rates reflect future spot movement… but at the same time high interest rates appreciate currency value due to capital coming in,,,, this is so confusing please shed some light on where my concepts are going wrong…..
In both cases we are looking at the cost of our goods as against the cost of the same goods bought in other countries.
Higher inflation will make the cost our goods quoted in our currency more expensive for purchasers in other countries. However, because (in theory) our currency will depreciate it means that purchasers in other countries will be paying less in their own currency.
In theory the two effects will cancel out and the cost in the purchasers currency will remain the same (and this is purchasing power parity). However in real life there are many other factors that determine the exchange rate other than the relative inflation rates.
Ohh, so same with interest rates, when high, initially our currency is appreciating until the market forces come into action and in accordance with interest rate parity, the exchange rate depreciates?
Sir, if theres an exam mcq on for instance effect of interest rate on exchange rates,
If its a true and false statement, then for an effect to be true in accordance with the parity theory the mcq must mention “in accordance with parity theory’’
Cuz there are two cancelling effects so how do we know in which context we answer like appreciate the exchange rate cuz greater currency demand due to high interest rates or Depreciate the currency due to parity theory???
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