Inflation Rate

Inflation rate is often considered as a determinant of the exchange rate as well. A high inflation should be accompanied by depreciation. The more so if other countries enjoy lower inflation rates, since it should be the difference between domestic and foreing inflation rates to determine the direction and the scale of exchange rate movements.

All this would be implied by a weak version of "one price law" stating that price dinamics of a good are the same worldwide, after taking into account nominal exchange rates. Thus, here the absolute level is not requested to be equalized but just the percentage differences in price.

If an hamburger costs in Japan 5% more than a year ago, while in USA it costs 8% more, then the dollar should have been depreciated this year by about 8-5=3%.

But in order to equalize the price dynamics of different goods, more than one exchange rate change may turn out to be "necessary".

In reference to the overall price level of the economy, if exchange rates would move exactly counterbalancing inflation dynamics, then real exchange rates should be constant. On the contrary, this is not true as a strict universal rule.

Still, even if this weak version of the "law" does not always hold, high inflation usually give rise to depreciation, whose exact dimension need not match the inflation itself or its difference with foreign inflation rates.

Autonomous dynamics on the forex market

Past and expected values of the exchange rate itself may impact on current values of it. The activities of forex specialists and investors may turn out to be extremely relevant to the detemination of market exchange rate also thanks to their complex interaction with central banks. Sophisticated financial instruments like futures on exchange rates may play an important role. Imitation and positive feedbacks give rise to herd behaviour and financial fashions.