Based on the observed empirical relationship between exchange rate movements and price levels, a country that consistently allows its currency to depreciate significantly against a major benchmark currency (like the U.S. dollar) is highly likely to maintain an inflation rate below that of the benchmark currency's country.
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Over a ten-year period, Country X actively managed its currency to ensure it never depreciated by more than 2% annually against the U.S. dollar, and its average inflation rate was 3%. Over the same period, Country Y allowed its currency to float freely, and it experienced an average annual depreciation of 20% against the U.S. dollar, with an average inflation rate of 22%. Based on the typical empirical relationship observed between these two variables, what is the most likely explanation for the
Central Bank Policy Evaluation
Exchange Rate Policy and Domestic Prices