Final answer:
A country with higher inflation and slower growth will experience a decrease in demand for its currency, leading to a lower exchange rate. This situation is worsened if the central bank does not intervene, and over time, exchange rates tend to align with purchasing power parity.
Step-by-step explanation:
When a country has a higher inflation rate than other countries and coupled with slower economic growth, it tends to lead to a depreciation of its currency. High inflation indicates the devaluation of the currency within a country, causing domestic goods to become more expensive relative to foreign goods.
Hence, there is less demand for the country's currency in the foreign exchange market, which in turn lowers the exchange rate. This scenario is exacerbated when the central bank does not intervene to stabilize the currency. Moreover, the long-term expectation is that exchange rates will adjust toward the purchasing power parity (PPP) rate, ensuring that internationally tradable goods have similar prices across different economies when values are converted to a common currency.
In the case of countries with large inflows of international capital, a sudden reversal resulting in outflows can lead to a rapid decline in the currency value, potentially causing a banking collapse and a deep recession. This situation reflects the lack of confidence from international investors, which can further drive the currency value down, as seen in historical examples from the late 1990s and early 2000s.