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Changes in the exchange rates and inflation
rates:

Let us understand now the relationship between exchange rate

and inflation. Suppose you notice that silver can be bought in
New York for $4.80 per unit and sold in Zurich for sfr7. then you
exchange your sfr for 7, @ $/1.3125 = $ 5.33 You make gross profit
of $.53 per unit: Such situations does not exist-not long as others
notice the disparity between the price of silver in Zurich and
price in New York, price will be forced down in Zurich and up
in New York until the profits opportunity disappear. Arbitrage
ensures that dollar price of silver is about the same in the two
countries. Of course silver is a standard and easily transportable
commodity but to some degree you might expect that same
forces would be acting to equalize the domestic and foreign i
prices of other goods.
vhose goods that can be bought more cheaply abroad
would be imported and that will force down the price
of domestic product. Similarly those goods that can be
bought more cheaply in USA will be exported and that
will force down the price of foreign product. vhis is
often called the law of one price or in more general
sense purchasing power parity theory. Law of one
price implies that any differences in the rates of
inflation will be offset by I change in exchange rate.

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 (ACvORS A(( CvING
CHANG RAv S.

In floating rate the exchange rates fluctuate because of change

in demand and supply of currency.

Principal factors affecting exchange rate are

1. Short term factors.
a. Commercial factors.
b. (inancial factors.

2. Long term factors

a. Currency and economic conditions.
b. Political and industrial conditions.
¢
 Case of Short verm vime Horizon

mD Country's current account balance is better indicator of

exchange rate trends. Surplus i.e. foreign exchange net
inflows from export earnings pushes country's currency value
higher as has happened in recent times with regard to rupee
vs. dollar. A nation·s international competitiveness and with
it the trend of its current account depends on different
factors. Inflation will diminish export after a certain future
period and increase imports.

2D High economic growth of a country strengthens the home

currency.

3D (oreign currency inflows from trade and services (banking,

shipping, tourism and so onD strengthens dometic currency.
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Long term factors:
1. conomic factors are of decisive importance. vhese can be ranging
from GDP growth rate, industry growth, agricultural growth,
inflation, interest rates and so on.

2. Non economic factors: Political or psychological factors can also

have a bearing on exchange rate behaviour, inflation, interest rates
and so on.

3. Market participants not only act on the basis known facts and
figures but they also base them selves on expectations. vhis factor
adds to volatility of foreign exchange market.

4. Speculative activities by private sector.

5. Industrial conditions: Current position and future outlook in the

industrial field are also important influences in the exchange
market.

 xistence of industry peace, stable level of wages,
prices, high level of efficiency of production
contribute to strengthening effect on the exchange
value of currency in the long period. Conversely
industrial unrest, unduly high cost of production,
inefficient production, have an adverse effect on the
exchange value of currency.