What happens over time to the currencies of countries with higher inflation rates than that of the United States? To those with lower inflation rates?

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What happens over time to the currencies of countries with higher inflation rates than that of the United States? To those with lower inflation rates?

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What happens over time to the currencies of countries with higher inflation rates than that of the United States? To those with lower inflation rates?

Explanation & AnswerSolution by a verified expert

Explanation

The term "Relative inflation" compares the inflation rate between the foreign country and the home country.
 
Changes in relative inflation determines the appreciation or depreciation in foreign currency in terms of the U.S. currency. When the inflation rate in the foreign country is high, the value of the foreign currency (in terms of the U.S. currency) tends to fall in the near future. As a result, more units of foreign currency can be purchased by one dollar.
 
On the contrary, if the inflation rate in the foreign country falls, the foreign currency value in terms of domestic currency will appreciate in the future. There is a greater demand for currency of a country with a lower inflation rate. Thus, over a period of time the currency of the countries with lower inflation rates appreciates to those with higher inflation rates.

Verified Answer

Over a period of time, the value of the currencies with higher inflation rate than that of the United States will depreciate with respect to the U.S. dollar. Comparatively, a similar situation will arise for currencies with lower inflation rates.

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