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Explain what happens to the value of the dollar relative to the euro as the result...

Explain what happens to the value of the dollar relative to the euro as the result of higher inflation in Germany compared to the United States. You may want to work the correct shifts of the supply and demand curves before you try and explain the results.

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A higher inflation rate in the Germany compared to United States will tend to increase the value of the Dollar because:

  • High inflation in the Germany means that Germany goods increase in price quicker than American goods. Therefore Germany goods become less competitive. Demand for Germany exports will fall, and therefore there will be less demand for Euro.
  • Also, Germany consumers will find it more attractive to buy American goods. Therefore they will supply Euros to be able to buy Dollars and Dollar imports. This increase in the supply of Euros decreases the value of Euros.


Increase in supply of Euros and fall in demand leads to lower value of the Euro against the Dollar.

Therefore, in the long run, changes in relative inflation rates should lead to a change in the exchange rates.

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