Although several economic and political factors can influence foreign exchange rate movements, by far the most important explanation for long-term changes in exchange rates is a differing inflation rate between two countries.

Question

Quizplus · Accepted Answer

According to the purchasing power parity theory, exchange rates should adjust to reflect differences in inflation rates between two countries in the long run. Higher inflation rate in one country relative to another will cause its currency to depreciate against the other currency. Therefore, differing inflation rates between two countries is the most important explanation for long-term changes in exchange rates.

Although Several Economic and Political Factors Can Influence Foreign Exchange