@farejul @Neyawn Please correct the explanation of statement 3, Q10 in today’s paper(Test 26).
In the explanation it is provided that high inflation leads to low interest rates i.e., it implies there is causative relation between the two. Fact is, low interest rate may be inflationary, though not always, but not vice versa. Also, there is no causative relation between interest rate & inflation.
Correct Explanation should be:
When domestic country is facing high inflation, it invariably means that aggregate price level in the domestic economy is high. When it is so, it will mean, for unchanged exchange rate, the domestic products have become costlier, which essentially implies that demand for domestic products by foreigners will fall & which is nothing but Exports of domestic country. Low exports will mean low foreign currency supply, coz foreigners in order to pay for our products get the currency exchanged by domestic currency. With unchanged demand for foreign currency & falling supply,the foreign currency price will rise & which is nothing but the exchange rate. Rise in exchange rate(domestic currency price of foreign currency) is depreciation.
Secondly, when domestic prices are very high, some of the demand for domestic products by domestic consumers may get shifted to foreign products which may have become cheaper at unchanged exchange rates. This means the imports of domestic country will rise. It essentially implies demand for foreign currency will rise, as we pay for our imports by exchanging domestic currency for foreign currency. It essentially means that with unchanged foreign currency supply & rising demand, the foreign currency price will rise which is nothing but the exchange rate. And rise in price of foreign currency in terms of domestic currency is nothing but depreciation of domestic currency.
Thus, under high inflation, falling exports & rising imports fuel the depreciation of domestic currency.
