Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country Y frequently engages in capital flows with the U.S. (such as financial investments). Everything else held constant, an increase in U.S. inflation would affect the exchange rate of Country Y's currency more than the exchange rate of Country X's currency.

Question

Quizplus · Accepted Answer

An increase in U.S. inflation would likely affect Country X's currency more because trade flows are more sensitive to inflation changes, impacting the demand for goods and services, whereas capital flows are more influenced by interest rates and investment returns.

Country X Frequently Engages in Trade Flows with the U