Inflation and Currency Depreciation: Explained

The Impact of Inflation on Currency Depreciation

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Question

Inflation contributes to the depreciation of a nation's currency only when a country's rate of inflation is ________ that of its trading partners.

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A. B. C. D.

C

If the rate of inflation in a nation is greater than that of its trading partners prices are rising faster at home than abroad. As a result, foreign consumers demand less of the nation's exports because they are now relatively more expensive. Falling demand for exports causes the demand for the nation's currency to decline and thus the currency depreciates.