Exchange rates and the inflation rate.

INTRODUCTION

A reading of the financial press suggests a belief that the underlying inflation rate is related significantly to the movement in the foreign exchange value of the dollar. (See Boyd, 1989; Passell, 1989; and Uchtelle, 1989a, 1989b.) This view has been supported by exchange rate and domestic inflation rate trends in the 1980s. The first part of the decade was associated with declining inflation and a strong dollar, while the latter part of the decade was characterized by a weaker dollar and a higher U.S. inflation rate.

While the simple statistical connection between inflation and exchange rates cannot be denied, recent research has questioned the causal nature ...

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