Question

An increase in the price level of a country, relative to another country's price level, will cause its currency to appreciate." Evaluate this statement

Answer 1

An increase in the price level of a country, relative to another country's price level, will cause its currency to appreciate."

An increase in the price level of a country, relative to another country's price level, will cause its currency to depreciate; and a decrease in the country's relative price level causes its currency to appreciate.

The exchange rate has signifucant relationship to the price level as it indicates a link between domestic prices and foreign prices. When there is inflation in the domestic economy, not matched by inflation abroad, thus price increases relative to another country's price level, the exchange rate ? (domestic currency price of foreign currency) has to increase, thus domestic currency will depreciate in terms of foreign currency.