Answer to Question #118658 in Macroeconomics for Karan Bhanot

Question

India's central bank has a higher inflation target than America's central bank. Does this tend to appreciate or depreciate the Indian rupee against the American dollar? Explain

Answer 1

Due to an increase in inflation, the central bank increases the interest rates. People will borrow less money from financial institutions and will have less money to spend and transact. Reserve Bank of India (RBI) might resort to increased interest rates too further increasing the effect on corporates.

The value of the currency will depreciate.

The prices of goods will rise dramatically. For instance when the oil prices rise it will lead to general rise in prices of all commodities since most people depend on oil in almost everything like cooking not forgetting transportation. The Indian market will be affected due to an increase in prices of imports.

The value of the rupee will hence fall( depreciate) while the United States dollar rise( appreciate).