I feel like there has to be something simple here I’m overlooking, but I’ve read these three statements 20 times and I’m still confused. - Inflation in the U.K., by itself, increases the real /£ exchange rate so that a unit of real goods and services in the U.K. costs relatively more in USD than it did at the base period. - Inflation in the U.S., by itself, decreases the real /£ exchange rate so that a unit of real goods and services in the U.K. costs relatively less in USD than it did at the base period. - An increase (decrease) in the nominal /£ exchange rate when inflation in both countries is equal increases (decreases) the real /£ exchange rate, and the cost of a unit of real goods and services in the U.K. increases (decreases) relative to what it was in the base period. In my economics classes I’ve learned that if US and the UK are trading and there is high inflation in the UK, then that means that the pound is weak relative to the USD, and that makes goods and services cheaper when purchasing in USD. So high inflation in UK=weak pound=good for exports to the US. It would appear that these statements are saying the opposite is true. Can someone help unconfuse me please?
Think about it this way:
Inflation in UK will increases prices of goods and services. To counter inflationary markets interest rates will rise. Higher interest rate in the UK will increase demand for UK currency, less demand for US currency ( cause technically you are earning higher interest on UK denominated currency). when demand for UK currency increase, currency value increase. So UK currency is stronger than the US and good and services will be more expensive when purchasing them in USD.