Why Turkey exhibits a high inflation after the depreciation rate in Turkish currency against US DOLLAR...

Why Turkey exhibits a high inflation after the depreciation rate in Turkish currency against US DOLLAR $?

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Expert Solution

This happens because of the purchasing power parity theory. It stats that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries.

Now, when the Turkish currency depreciates against USD, this equilibrium is disturbed. Turkish goods now become more competitive in the world markets (purchasing power of USD increases in Turkey). To restore equilibrium, the prices in turkey have to rise as an increase in the price of goods compensates for the depreciation of currency and the purchasing power equilibrium is restored. (Since the price of goods in Turkey has increased now, the purchasing power of USD is the same in Turkey - it can buy the same amount of goods)

Thus, depreciation is followed by inflation.

Rahul Sunny answered 1 year ago

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