Currency Appreciation and impact on Inflation - Chain of Reasoning (2024)

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Currency Appreciation and impact on Inflation - Chain of Reasoning? ›

Chain of Analytical Reasoning

When the value of a currency changes, prices for goods traded using that currency can be affected. A currency appreciation (when the value increases over time) results in a lower effective price for imported goods; currency depreciation (when the value decreases over time) translates to higher import prices.

In general, inflation tends to devalue a currency since inflation can be equated with a decrease in a currency's buying power. As a result, countries experiencing high inflation tend to also see their currencies weaken relative to other currencies.

As a consequence, currency depreciations and appreciations have political consequences. Currency appreciation benefits consumers, as it makes foreign goods cheaper, but it harms national producers who face greater competition with foreign producers. A depreciation has the opposite effect.

' According to this view, the decline in the value of the dollar raises the dollar price of imported goods and, therefore, the prices paid by U.S. citizens as well. The con- sequence is inflation.

Currency appreciation is an increase in the value of one currency in relation to another currency. Currencies appreciate against each other for a variety of reasons, including government policy, interest rates, trade balances, and business cycles.

On the one hand, if a currency appreciates, all of its imported goods get a lot cheaper. If a country tends to import a lot more goods than they export, then an appreciated currency might be desirable. But on the other hand, if a country relies heavily on exports, an appreciating currency isn't such a great thing.

A strengthening dollar means U.S. consumers benefit from cheaper imports and less expensive foreign travel. U.S. companies that export or rely on global markets for the bulk of their sales are financially hurt when the dollar strengthens.

What is causing inflation right now? ›

As the labor market tightened during 2021 and 2022, core inflation rose as the ratio of job vacancies to unemployment increased. This ratio is used to measure wage pressures that then pass through to the prices for goods and services.

To summarize, the money supply is important because if the money supply grows at a faster rate than the economy's ability to produce goods and services, then inflation will result. Also, a money supply that does not grow fast enough can lead to decreases in production, leading to increases in unemployment.

Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.

The Bottom Line. Inflation occurs when prices rise in an economy and/or the purchasing power of money loses value.

When the central bank increases interest rates, borrowing becomes more expensive. In this environment, both consumers and businesses might think twice about taking out loans for major purchases or investments. This slows down spending, typically lowering overall demand and hopefully reducing inflation.

Inflation is measured as a percentage: If the inflation rate is 1% (lower inflation), the purchasing power of money will be 1% less a year later. If the inflation rate is 5% (higher inflation), the purchasing power of money will be 5% less a year later.

When a country decides to devalue their currency to make its goods and services cheaper, it can cause an increase in inflation. Inflation means that as the prices of goods and services rise, the value of a currency declines. The value of a currency is based on the goods and services that a country produces.