question about the exchange rate (1 Viewer)

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can someone explain this:

'If a central bank buys foreign exchange from local firms or households in exchange for domestic currency, that will increase the monetary base and money supply, causing the exchange rate to depreciate against the foreign currency.'

I dont understand why if there is an increase in money supply it will lead to a depreciation of the $AUD?
 

blyatman

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Isn't that the same concept behind inflation? An expansion of the money supply reduces the purchasing power of each individual dollar.
 

kevin3314

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Isn't that the same concept behind inflation? An expansion of the money supply reduces the purchasing power of each individual dollar.
Yes, this is true but another way to understand the concept is that because there is increased supply and assumed that demand is held at the same level(Theoretical situation.) This means that by supply and demand, the equilibrium point will fall -> Price of exchange falls(E/r)
 

blyatman

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Yes, this is true but another way to understand the concept is that because there is increased supply and assumed that demand is held at the same level(Theoretical situation.) This means that by supply and demand, the equilibrium point will fall -> Price of exchange falls(E/r)
Yes I thought about explaining it in terms of supply and demand, but the original question phrased in using the words of an expansion in the money supply, which made me end up equating it with inflation. But yes, supply and demand: if you go on Forex and sell domestic currency for a foreign currency at the market rate, you'd push the price of the domestic currency down.
 

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