ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -Interest rates, inflation, and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values.

Detailed explanation-2: -How Does Inflation Affect Currency Conversion Rates? When inflation is higher, this tends to have a depressing affect on the value of a country’s currency. This is because increased inflation reduces the currency’s buying power, which weakens it against other currencies.

Detailed explanation-3: -Key Takeaways A rising level of imports and a growing trade deficit can have a negative effect on a country’s exchange rate. A weaker domestic currency stimulates exports and makes imports more expensive; conversely, a strong domestic currency hampers exports and makes imports cheaper.

Detailed explanation-4: -Exchange rate movements and inflation A depreciation (decline in the effective exchange rate) is expected to cause the domestic price of imports to rise and, depending on a host of factors, higher consumer prices (a positive pass-through).

Detailed explanation-5: -However, inflation leads to increase in imports, as money supply in the market increases, which increases the purchasing power of money. Hence, people start demanding more.