Question

(1) If the interest rate in Japan is greater than the interest rate in the United States, other things held constant, according to interest rate parity, will the Japanese Yen appreciate or depreciate against US dollar?

(2) If Mexico experiences a hyperinflation (very high inflation) relative to the US, other things held constant, according to the parity condition, will the Mexican Peso appreciate or depreciate against US dollar?

Answer 1

1) If the interest rate in Japan is greater than the interest rate in the United States, other things held constant, according to interest rate parity, Japanese Yen appreciates against US dollar.

Higher interest rates increase the value of a Country's currency. Higher interest rates tend to attract foreign investment, increasing the demand for a country's currency. In opposite, lower interest rates tend to be unattractive for foreign investment and reduces the currency's relative value.

2) If Mexico experiences hyperinflation (very high inflation) relative to the US, other things held constant, according to the parity condition, will the Mexican Peso depreciates against US dollar.

If a government is not properly run during hyperinflation, citizens can also lose confidence in the value of their country's currency. When money is perceived to have little or no value, people start to accumulate goods and valuable goods. As prices rise, basic commodities such as food and fuel become scarce and prices goes upward. The lack of confidence is reflected in the outflows of investments leaving the country. When these outflows occur, the value of the country's currency declines as investors sell their country's assets in exchange for another country's assets.