Higher US Inflation: The Dollar Depreciates
Higher US inflation pushes Americans toward foreign goods, increasing the supply of dollars and depreciating the dollar.
Higher US Inflation: The Dollar Depreciates
Foreign Exchange Market (USD)Higher US inflation pushes Americans toward foreign goods, increasing the supply of dollars and depreciating the dollar.
Start at Equilibrium
The market for dollars begins in equilibrium where the demand for dollars (D$) equals the supply of dollars (S$). The vertical axis measures foreign currency per dollar.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Higher US Inflation: The Dollar Depreciates, step by step
- 1
Start at Equilibrium
The market for dollars begins in equilibrium where the demand for dollars (D$) equals the supply of dollars (S$). The vertical axis measures foreign currency per dollar.
- 2
US Inflation Rises, Supply Shifts Right
US inflation rises, so American-made goods become relatively more expensive than foreign goods. Americans buy more imports, and to pay for them they must supply more dollars to the foreign exchange market, so the supply of dollars shifts right.
- 3
The Dollar Depreciates
At the new equilibrium the exchange rate is lower, so each dollar buys less foreign currency and the dollar has depreciated. The equilibrium quantity of dollars traded rises as the larger supply is absorbed by the market.
Where it ends up
The dollar depreciates while the equilibrium quantity of dollars traded rises, as Americans supply more dollars to buy relatively cheaper foreign goods.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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