How does a low rate of inflation affect the economy?

How does inflation affect the exchange rate?

• My textbook says, "When our inflation rate is rising at a faster rate relative to our trading partners it can harm exporters and benefit importers." Which implies that inflation leads to appreciation - but I have read that inflation leads to depreciation, so it doesn't makes sense.

• Answer:

  Inflation can lead to appreciation. Whether inflation leads to appreciation or depreciation depends on a number of factors - one major factor is how the central bank of the given country handles inflation. If the central bank increases interest rates so that the real interest rate counteracts inflation, then global investors are more interested in holding currency in the given country, thus causing appreciation. If the central bank doesn't react however, and there is no response to inflation, then the currency can depreciate.