Final answer:
High inflation leads to a weaker currency and a discrepancy from the purchasing power parity value, demonstrated by the historical example of the Mexican peso's devaluation during high inflation periods.
Step-by-step explanation:
When a country experiences high inflation, its currency tends to have a weaker exchange rate due to diminishing purchasing power. This is exemplified by the Mexican peso's situation during 1986-87 when an inflation rate of over 200% led to a significant decrease in the peso's value. The demand for the peso on foreign exchange markets dropped, and its supply increased, consequently lowering the equilibrium exchange rate from $2.50 per peso to just $0.50 per peso. In terms of purchasing power parity (PPP), a country with high inflation is less likely to have an exchange rate equal to its PPP value compared to a country with a low inflation rate. This is because over time, exchange rates adjust to reflect the inflation differences; thus, high inflation leads to a devaluation of the currency, moving away from parity with other currencies of lower inflation economies.
In the medium run, varying inflation rates directly influence exchange rate markets, causing countries with higher inflation to experience weaker demand for their currency, leading to currency depreciation. Nevertheless, over the long term, exchange rates tend to adjust towards the PPP rate, aligning the prices of internationally tradable goods in different economies.