Good Morning Folks. I have been provided with an opportunity to share my ideas and views on the topic
‘Link Between Exchange Rate And Inflation’

What exactly is Inflation ; This may be defined as the rate at which the level of prices for services or goods is rising and due to which purchasing power falls.
Central bank attempts to stop severe inflation so that the excessive growth of prices is minimal

Example: Cost of 1 mineral water bottle is $1 in 01’Jan 2010
Rate of inflation rises by 2%
The cost on 01’ Jan 2011 is $1.2

Simplifying:
A house in 1940 would cost $10,000
Because of the change in inflation rate (rise)
Now the same house would cost $1,00,000

Exchange Rate (FOREX RATE or FX RATE)
Between two currencies is the rate at which one currency will be exchanged for another
Basically this is the value of one currency in terms of another.
Example: $1= INR 30

During the same we come across a term (PURCHASING POWER PARITY) also denoted as PPP which has been explained as follows:
(PPP) The measure of long term equilibrium exchange rates based on relative price levels. This was given by GUSTAV CASSEL in 1918
This concept is based upon the law of one price. The idea is that in the absence of transaction cost and official barriers to trade identical goods will have same price indifferent markets when the price is expressed in form of one currency.
The link between exchange rate and inflation is explained using an example;
Take two hypothetical countries:

Country A
Inflation Rate= 0%
Currency= Dollar

Country B
Inflation Rate= 50%(assumption)
Currency= Rupees

On 01’Jan 2010
Rate of a mineral water bottle= $1 because the inflation rate of country A = 0% the price will be the same on 01’Jan 2011. The Price Has not changed

Rate of mineral water bottle =Rs.20 will change to Rs.30 because of 50% inflation in Country B.
i.e now rupees 30=$1 which shows that the exchange rate between rupees and dollar is 30.this means we need 30 rupees to purchase 1 dollar on foreign market .Now that the rate of inflation is different in country A and country B the relative price of goods will change.

Inflation and how it is measured?
The value of dollar does not stay constant when there is inflation. The value of dollar is observed in terms of purchasing power.

{inflation ↑ will Have an effect on purchasing power↓}
Most of the central banks try to sustain an inflation rate of 2%- 3%.

Conclusion
We see that the link between the exchange rate and inflation holds an inversely proportional attitude in economic terms i.e. with a rise in inflation in one particular country we will see a gradual decrease in its purchasing power and hence the value of its currency will decline.



Presented by :Prateek Kumar Sharma
Mba (1A)
Presented to : Mr Gurdeepak Singh.