What is the role of inflation in currency depreciation?

Answer 1

Essentially, inflation -- increasing prices over time -- is currency depreciation, although it is possible for a particular denomination to decrease in value in relation to other world currencies while still maintaining its purchasing power at home.

For example, one US dollar may be exchanged for 0.64 euro today and only 0.60 euro next week but still purchase, say, four of those huge gum balls you see in the machines at the Toys R Us. Or it could purchase (as of this writing) one liter of gasoline. (The rapidly increasing price of gas is due mainly to increasing world demand, although the weakening dollar is also a culprit in the current high price of a barrel of oil. The demand for gum balls, on the other hand, is pretty flat.)

Inflation, per se, is not necessarily a bad thing, as long as the rate of inflation stays below the rate at which wages increase. (In fact, price deflation is generally a more serious problem.) One dollar may not purchase as much as it would have 50 years ago, but people have a lot more of them than they did 50 years ago, so the cost of living is generally much lower than it was in 1958.

In the US, the Federal Reserve Bank can sell or purchase investment instruments, such as bonds, to either decrease or increase the money supply. If the money supply goes up, prices generally increase, inasmuch as there are more dollars chasing after the same amount of goods and services.