Could you please help me with my understanding of the relationship between Inflation, Real interest rates, and Purchasing power.
According to CFAI p. 474:
“the real exchange rate that an individual faces is (…) a decreasing function of the domestic price level”
According to CFAI p. 475:
“the higher the price (real exchange rate), the lower your relative purchasing power”
So according to this:
Domestic inflation (higher prices) leads to a lower real exchange rate, leading to a higher purchasing power. However, this is - at least from my understanding - not right, because increasing inflation leads to decreasing purchasing power.
Could someone explain the relationship between these three factors and where my understanding is wrong?
Thanks in advance.