The reltaionship between devaluation and inflation

How does inflation affect the exchange rate between two nations? By Investopedia Updated January 10, — 5:

The reltaionship between devaluation and inflation

Why is it that the value of the exchange rate falls when there is higher inflation? How inflation affects the exchange rate A higher inflation rate in the UK compared to other countries will tend to reduce the value of pound because: Therefore UK goods become less competitive.

The reltaionship between devaluation and inflation

Demand for UK exports will fall, and therefore there will be less demand for Pound Sterling. Also, UK consumers will find it more attractive to buy European imports. Therefore they will supply pounds to be able to buy Euros and the Euro imports.

This increase in the supply of pounds decreases the value of Pound Sterling. Therefore, in the long run, changes in relative inflation rates should lead to a change in the exchange rates. In the post-war period, the UK experience a higher inflation rate than Germany.

This caused the Pound Sterling to depreciate against the German Mark. It was a reflection that German industry was becoming more competitive than UK industry.

Also, markets anticipate future inflation. If they see a policy likely to cause inflation e. How the exchange rate affects inflation If there is a depreciation in the exchange rate, it is likely to cause inflation to increase.

Import prices cheaper Why a depreciation causes inflation A depreciation means the currency buys less foreign exchange, therefore, imports are more expensive and exports are cheaper. After a depreciation, we get: The price of imported goods will go up because they are more expensive to buy from abroad Higher domestic demand.

Cheaper exports increases demand for UK exports. THere is also a reduction in demand for imported goods, shifting consumption to domestic goods Therefore, there is an increase in domestic aggregate demand ADand we may get demand pull inflation.

Less incentive to cut costs. Manufacturers who export see an improvement in competitiveness without making any effort. Some argue this may reduce their incentive to cut costs, and therefore, we get higher inflation over the long term.

Therefore, a depreciation causes both cost-push inflation and demand pull inflation. Example of depreciation causing inflation in the UK During andwe saw a significant fall in in the value of the Pound.

Evaluation of impact on inflation The rise in UK inflation in was also due to higher oil prices. The effect on inflation was limited because in the UK was in recession, which reduced inflation.

The impact also depends on the elasticity of demand and whether firms will pass on the exchange rate costs onto consumers. For example, firms may reduce profit margins rather than increase the price of imports.Surging prices are not inflation, they are a signal of inflation.

Inflation is by definition the expansion of the money supply, which dilutes the value of the money already in circulation, which results in higher prices to purchase the same goods and services. The stability between inflation and money is not the primary success of this policy. It is with the central bank increasing its accountability; the transparency of the policy associated with inflation targeting has made the central bank vastly accountable to the public and the government.

Inflation and Exchange Rates Tejvan Pettinger July 17, economics Readers Question: Why is it that the value of the exchange rate falls when there is higher inflation?

The rate of inflation in a country can have a major impact on the value of the country's currency and the rates of foreign exchange it has with the currencies of other nations.

Essay title: Devaluation

However, inflation is just one factor among many that combine to influence a country's exchange rate. So yes indeed, there is certainly a relation between currency devaluation and increased prices, and potentially an increase in the rate of inflation, if the government doesn’t have the political will to resist the political pressure for expansionary monetary policy that a devaluation will generally unleash.

Abstract. The United States (US) dollar-based gold price and the exchange rate between the Australian dollar and the US dollar (AUD/USD) have a combined and significant impact on both the trend of the Australian minerals industry and the overall Australian economy.

The Reltaionship Between Devaluation And Inflation - Free Essays