Answer to Question #283725 in Macroeconomics for ABEX

Question

26. 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

Importing and exporting activity can have an impact on a country's GDP, exchange rate, inflation, and interest rates. A increasing trade deficit and rising imports can have a negative impact on a country's exchange rate. A weaker home currency encourages exports while raising the cost of imports; on the other hand, a strong domestic currency discourages exports while lowering the cost of imports. Higher inflation can have a direct influence on input costs like materials and labor, which can affect exports.