Thailand Dilemma Case Study

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inflation has a direct impact on exchange rates because it has a direct impact on the purchasing power of both (or all) currencies involved in a comparison of inflation rates. That is, inflation by definition reduces the purchasing power of a currency, and thus if two currencies have different rates of inflation (as they almost always will, on some level or another) they will have different rates of purchasing power reduction. These differing rates of purchasing power reduction lead to different and constantly changing exchange rates, and in fact are a major driver of fluctuations in exchange rates. For example, if the inflation rate is higher in country A than in country B, country A's currency is experiencing a faster reduction in its purchasing power than is country B. This means that the currency in country B. can buy more than the currency in country A, unit for unit and all else being equal, and thus it will take more of currency A to buy some of currency B -- a greater amount of A is needed in order to reach the same purchasing power as B.

A company with a foreign investment in production and/or retail sales is also directly impacted by such fluctuations, especially when a currency is free-floating such as the baht in this case. If the company's home country experiences a faster rate of inflation, its costs in the foreign country will increase, while at the same time the revenue brought in will increase in value as well -- the baht can be traded in for a larger amount of the home country's currency.

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In the reverse situation, i.e. rapid inflation of the baht, the company would experience an initial cost savings in production (though wages would eventually need to rise to keep up with inflation) and a reduction in revenue value (that would also be offset by price changes).

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Purchasing power parity is impossible to achieve in the short run due to a variety of factors, including the individual changes in demand amongst various markets, political situations that have nation-specific economic impacts, and the trade barriers that exist in the real world: tariffs, shipping costs, differences in regulations, etc. If countries were to commit themselves to more long-term and concrete trade arrangements with specific purchase agreements, rather than letting markets (for the most part) dictate when, what, and how much gets traded, purchasing power parity might hold better in the short-term as expectations and evidence of purchasing power would be more certain. Should this occur on any meaningful scale, however, the inefficiencies and economic….....

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