Question

Suppose you are focusing on the $ vs. euro relation. Today’s exchange rate is €0.909/$ or $1.10/€. What would you expect about the value of $ against euro if the future change in the inflation in US turns out to be higher than that in Euro zone? Why? (10 pts)

Answer 1

If the future inflation is higher in United States, it will mean that the value of American dollars is going to decrease in respect to European euros, because when there will be inflation in the domestic economy,it will mean that, there will be a lower value of currency available to expend, because of higher inflation and loss of disposable value of the domestic currency so similar amount of money will be worth lower due to effect of inflation in the domestic currency and it will mean that the value of DOLLAR will DEPRECIATE due to increase in inflation in the United States economy and hence it can be summarised that the overall value of American dollar will DEPRECIATE in respect to the European euros.