Answer to Question #283577 in Macroeconomics for ABEX

Question

4. A country faced an unexpected build-up of foreign exchange earning

following a positive price shock on the country’s main export in the international market. This gain was, however, accompanied by a soaring

inflation. How and under what conditions, if any, can the build-up of

the foreign exchange reserve trigger inflation?

Answer 1

The increase in the foreign exchange reserve leads to the cheaper domestic goods for foreign consumers, resulting in the increase of exports and total demands and prices. The increase in the foreign exchange price raises the inflation rate.