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. As per the interest rate parity, higher interest rate country's exchange rate would depreciate by the difference in the interest rates.

For example, Japan's interest rate is 3% and United Nations interest rate is 1%, then Japan's currency depreciates by 2% as per the interest rate parity.

2. Here also, Mexico's currency depreciates against US currency because of higher inflation, foreigners will pull out money from Mexico leading over supply of Mexican Pesos resulting in depreciation of the currency