Final answer:
Differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate, meaning that when one country has a higher inflation rate compared to another, the currency of the country with higher inflation will depreciate in value.
Step-by-step explanation:
When it is stated that differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate, it means that when one country has a higher inflation rate compared to another, the currency of the country with higher inflation will depreciate in value. This means that it will take more units of that currency to buy the same amount of goods or services. On the other hand, the currency of the country with lower inflation will appreciate in value, meaning it will take fewer units of that currency to buy the same amount of goods or services.
For example, let's say Country A has a higher inflation rate compared to Country B. As a result, the currency of Country A will depreciate, making it cheaper compared to the currency of Country B. This means that it will take more units of Currency A to buy the same amount of Currency B. Over time, this change in exchange rates tends to balance out, resulting in an equal but opposite change in the spot exchange rate.
Overall, differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate, as the exchange rate adjusts to reflect the relative purchasing power of each currency.