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Topic
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In evaluating the impact of relative inflation rates on the demand for a foreign currency, which of the following is true?
a. Inflation is irrelevant to currency demand
b. As inflation associated with a foreign economy increase in relation to a domestic economy, demand for the foreign currency falls.
c. As inflation associated with a foreign economy decrease in relation to a domestic economy, demand for the foreign currency falls.
d. As inflation associated with a foreign economy increase in relation to a domestic economy, demand for the foreign currency increases.
The answer is b. I choose d. As says in Becker text book “When domestic inflation exceeds foreign inflation, holders of domestic currency are motivated to purchase foreign currency to maintain the purchasing power of their money. The increase in relation to the domestic foreign currency forces the value of the foreign currency to rise in ration to the domestic currency, thereby changing the rate of exchange between the domestic and foreign currency”. According to what says in the text book I think the choice would be d.
Becker’s answer said the foreign currency will appreciate and then cause demand decrease. But I think foreign currency appreciation caused by demand increase first, and then the increased price drag down demand.
Can any one explain that? Thanks
AUD-74,75 11/2014
REG-80 04/2015
FAR-74, 91 11/2015
BEC-79 08/2015
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