High Low Inflation Rate

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This paper verifies whether a rise in Inflation rate can lead to Currency appreciation or not. Our primary hypothesis was that currency depreciation is actually the inevitable cause of a rise in the inflation rate; however there can also be a few instances where in fact a rising price level can lead to a fall in the Exchange rates. The paper begins with a summarised description along with the literature review involving cases where the economists and researchers support “Depreciation” or “Appreciation” followed by a rise in the price level. Then we have showcased an empirical analysis using a simple regression (OLS method) to capture how the net inflation rates are correlated to the Exchange rates. Our end result, although somewhat
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Let’s take the case of a bond market, the low cost of borrowing, induces the borrowers to supply more bonds – as a result bond prices decrease and since bond prices and interest rates have a negative relationship the interest rates rises. This phenomenon is popularly known as the FISHER EFFECT, named after Irving Fisher. The higher interest rates in turn causes the exchange rates to fall in the Foreign Exchange market, causing a currency appreciation. Clarida and Waldman (2008) in their paper “is bad news about inflation good news for the exchange rate” ; examined a minor sample comprising 10 advanced nations – Canada, Euro Zone, The Great Britain, Australia, Norway, Sweden, Japan, New Zealand, Switzerland and the United States – they analyzed the exchange rate volatility during the period lasting from five minutes prior to the announcement of an inflation to five minutes afterwards. They observed that on average, announcement of an unexpectedly high inflation does indeed lead the exchange rates to fall, i.e. a currency…show more content…
Therefore, it causes depreciation of currency. If inflation of one country is increased, its real interest rate drops correspondingly, for which its currency becomes less attractive to investors and its value in the international currency market would decrease. This in turn also causes depreciation. Inflation is generally a bad thing for an economy, as it discourages investment, especially in fixed income instruments (bonds and currencies). It hurts consumers, who see their pay checks become worthless, and their costs increase. During inflationary periods, investors do not want to buy debt instruments issued by a country, because they are denominated in the currency that is being devalued due to the inflation. Currency depreciation, if orderly and gradual, improves a nation’s export competitiveness and may improve its trade deficit over time. But abrupt and sizeable currency depreciation may scare foreign investors who fear the currency may fall further, and lead to them pulling portfolio investments out of the country, putting further downward pressure on the
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