How does a countries inflation rate affect its exchange rate?
Answer:
According to purchasing power parity,
P = E * Pf
where P = price level in home country and Pf is the price level in a foreign country, and E is the exchange rate between the home and the foreign country.
If home-country inflation is growing at 15% per year, and foreign-country inflation is growing at 5% per year, then the PPP equation says that the exchange rate must be increasing at a 10% rate (15-5=10).
Hope this helps.
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