Question

Explain how inflation differential determine the value of a currency.

Answer 1

Inflation, refers to a situation whereby the prices increase and the purchasing value of money decreases

The value of the currency is understood by it's demand very similar to the value of goods and services

Relation of Inflation differential with currency value

A country exhibiting a rising currency value means it is facing a consistently lower inflation rate because its purchasing power is increasing relative to other currencies. This is usually followed by lower interest rates.

Back in the 20th century Switzerland ,Germany, and Japan, whereas the U.S. and Canada achieved low inflation later.

A country exhibiting a depreciation in their currency value is facing a higher inflation rate typically because their purchasing power is decreasing in relation to their trading partners. This is usually also followed by higher interest rates.

NOTE : Low interest rates leads to high inflation, higher inflation leads to high interest rates, the high interest rates therefore lead to low inflation