question about the exchange rate (1 Viewer)

[RakeshCristoval]

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?

 

[kevin3314]

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)