<blockquote>
  <p>I've seen both arguments. [...]</p>
</blockquote>

<p>You are comparing two arguments that are not incompatible. The first one scenarizes a situation within which the CB does nothing, while the second argument implies a CB that counteracts. <sub>Note that when the CB hikes its rates, it also has some forex-unrelated domestic consequences going in the same direction.</sub></p>

<blockquote>
  <p>Which of these two views make more sense theoretically [...] ?</p>
</blockquote>

<p>As explained, both. It is all about politics actually. There is <em>no deterministic math</em> here. Put differently, <em>human is an unpredictable variable in the model</em>.</p>

<blockquote>
  <p>Which [...] is more supported empirically ?</p>
</blockquote>

<p>Once again, both. Notorious investments such as <a href="https://www.investopedia.com/articles/investing/090815/3-best-investments-george-soros-ever-made.asp" rel="nofollow noreferrer">Soros</a>'s against the British pound in 1992 perfectly illustrates the second argument. But if Britain hadn't done anything to keep the pound's value high (in relation to the German mark), it would have decreased because of inflation.</p>

CC BY-SA 4.0
2020-05-14T15:44:25.173Z
What about the argument, for the second case, that a rate hike by the CB is actually inflationary and not deflationary as is usually thought of since the government is a net payer of interest and thus a rate hike increases private income. I've mainly seen this argument from Post-Keynsians and MMT'ers.
Metrician
CC BY-SA 4.0
2020-05-14T21:28:33.397Z
@Metrician Since your additional question is independent of the current post, consider asking another question. I am sure that you understand that comments are not adapted for Q&As. Any question regarding my above answer ?
keepAlive
CC BY-SA 4.0
2020-05-14T23:22:11.510Z
I thought it related to it since if they're correct that would mean that a rate hike should further depreciate the currency's value eitherway in those two cases. Other than that everything else is clear thanks.
Metrician
CC BY-SA 4.0
2020-05-14T07:43:49.033Z
2020-05-14T08:04:53.600Z
2020-05-14T08:04:53.600Z
keepAlive
<p>I've seen both arguments. From my understanding an increase in the rate of inflation should decrease the value of the currency since it's by definition a depreciation in its purchasing power. But I've heard people argue that an increase in inflation actually increases the value of a currency since that country's Central Bank is expected to hike its rates which makes that country's financial assets more attractive and thus increases that country's currency value through an increase in the demand for that currency.</p>

<p>Which of these two views make more sense theoretically and which is more supported empirically?</p>

CC BY-SA 4.0
2020-05-13T17:06:29.417Z
Currency markets are a financial market. If any variant of the “efficient market hypothesis” holds, it is very difficult to beat the market. If there were a solid statistical relationship between inflation - which also can effectively be traded in the inflation swap market - and currencies, it would probably imply an opportunity to make money “relatively easily.” This logic would suggest that empirical linkage will be weak. On a longer-term basis, you could look up “purchasing power parity.”
Brian Romanchuk
<inflation><currency><exchange-rates>
Does inflation/expected inflation in a given country devalue its currency or increase its value?
Metrician
# Does inflation/expected inflation in a given country devalue its currency or increase its value?

(Asked by: username_0 on 2020-05-13)

I've seen both arguments. From my understanding an increase in the rate of inflation should decrease the value of the currency since it's by definition a depreciation in its purchasing power. But I've heard people argue that an increase in inflation actually increases the value of a currency since that country's Central Bank is expected to hike its rates which makes that country's financial assets more attractive and thus increases that country's currency value through an increase in the demand for that currency.

Which of these two views make more sense theoretically and which is more supported empirically?

**Tags:** inflation, currency, exchange-rates
> **Comments:**
> **username_1**: Currency markets are a financial market. If any variant of the “efficient market hypothesis” holds, it is very difficult to beat the market. If there were a solid statistical relationship between inflation - which also can effectively be traded in the inflation swap market - and currencies, it would probably imply an opportunity to make money “relatively easily.” This logic would suggest that empirical linkage will be weak. On a longer-term basis, you could look up “purchasing power parity.”  

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## 1 answers

### Answer by username_2 on 2020-05-14. Score: 1 | Accepted answer

> I've seen both arguments. [...]

You are comparing two arguments that are not incompatible. The first one scenarizes a situation within which the CB does nothing, while the second argument implies a CB that counteracts. Note that when the CB hikes its rates, it also has some forex-unrelated domestic consequences going in the same direction.

> Which of these two views make more sense theoretically [...] ?

As explained, both. It is all about politics actually. There is *no deterministic math* here. Put differently, *human is an unpredictable variable in the model*.

> Which [...] is more supported empirically ?

Once again, both. Notorious investments such as [Soros](https://www.investopedia.com/articles/investing/090815/3-best-investments-george-soros-ever-made.asp)'s against the British pound in 1992 perfectly illustrates the second argument. But if Britain hadn't done anything to keep the pound's value high (in relation to the German mark), it would have decreased because of inflation.

> **Comments:**
> **username_0**: What about the argument, for the second case, that a rate hike by the CB is actually inflationary and not deflationary as is usually thought of since the government is a net payer of interest and thus a rate hike increases private income. I've mainly seen this argument from Post-Keynsians and MMT'ers.  
> **username_2**: @Metrician Since your additional question is independent of the current post, consider asking another question. I am sure that you understand that comments are not adapted for Q&As. Any question regarding my above answer ?  
> **username_0**: I thought it related to it since if they're correct that would mean that a rate hike should further depreciate the currency's value eitherway in those two cases. Other than that everything else is clear thanks.  

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