How Do Prices Influence Exchange Rates?
A positive relationship exists between the inflation rate and the level of money supply
1 When the growth in the money supply is greater than the growth in output, inflation will occur
2 PPP theory suggests that changes in relative prices between countries will lead to exchange rate changes, at least in the short run
a country with high inflation should see its currency depreciate relative to others
3 Empirical testing of PPP theory suggests that it is most accurate in the long run, and for countries with high inflation and underdeveloped capital markets