How does inflation affect the supply of the dollar in the foreign exchange market?

I need to graph the change in the supply of the dollar after inflation in the foreign exchange, but I do not know whether the supply would decrease or increase after inflation.

Please help!How does inflation affect the supply of the dollar in the foreign exchange market?When Bush/Cheney took Office the Euro cost about eighty cents USD.

When they left Office it cost just about $1.60, or double the cost

of eight years earlier. So the USD lost half it's value

against the EURO.How does inflation affect the supply of the dollar in the foreign exchange market?I'm not an economist by profession but I'd think it would work something like this:



The Federal Reserve bank is asked by the govt. to print more money. the value of the new money is secured by the money that's currently in the market and the overall buying power of the dollar goes down to accommodate for this increase in paper currency(inflation). As inflation increases the dollar falls in value against other stabler currencies (pound, EURO). When the dollar falls in value other countries once again begin to purchase American products (in theory) because of the price difference between the two currencies.



So to make a long story short when the dollar is strong other countries hold them for security and when it's weak they begin to place them back into circulation to purchase American goods and services.



(I hope that's right, can someone please confirm this for him)How does inflation affect the supply of the dollar in the foreign exchange market?In the monetarist approach you need the following equations to establish that relationship:



Quantity theory of money: M=k*P*Y (M: demand for money, k: velocity, P price level, Y: economic output)

Exogenous supply of money: L

Purchasing Power Parity (PPP): Pd=E*Pf (Pd: domestic prices, Pf: foreign prices, E: exchange rate).



The static equilibrium is given as: P = M/L and E=Pd/Pf.



You can draw a diagram with four quadrants, where you need the following two (counter clockwise): (1) M and Pd axis, (2) Pd and Pf axis.



If you increase the money supply in the first quadrant, i.e shift the money supply curve to the right, you will be able draw the following conclusion: The increase in the domestic money supply will result in an excess supply of money. Since the output is fixed, this must result in an increase of the domestic price level (due to the quantity theory). This increase in the domestic price level with a fixed foreign price level results in a depreciation of the exchange rate (due to PPP): increase in E.



Hope this helps!