In this article
- The direct connection between price tags and exchange rates
- Purchasing power parity and the law of one price
- Turkey's lira: what happens when interest rates ignore inflation
- Argentina and the extreme end of currency erosion
- The feedback loop of imported inflation
- How central banks attempt to break the cycle
Purchasing power parity and the law of one price
Economists explain this link using purchasing power parity, often abbreviated as PPP. The foundation of the theory is the law of one price. In an open market without trade barriers or transport costs, an identical product should cost the same whether you buy it in New York, London, or Tokyo once you convert the currencies.
Consider an electronics manufacturer selling a standardized laptop. If the laptop costs $1,000 in the United States, its price across the Atlantic at today's rate would be 895.90 EUR. If European inflation suddenly doubled domestic production costs while American costs remained flat, buyers would turn away from European exports at the existing exchange rate. To keep those computers competitive on global shelves, the euro would need to lose half its value against the dollar to restore balance.
In reality, exchange rates do not match PPP every day. Tariffs, freight bills, local taxes, and non-tradable services like restaurant rent or haircuts create permanent wedges between national price levels. Yet when two economies run similar, low inflation over long stretches, their currencies remain remarkably anchored. Between the euro and the US dollar, for example, the 10-year change stands at just +1.8%, reflected in our EUR to USD exchange rate tracking.
Turkey's lira: what happens when interest rates ignore inflation
When inflation breaks away from global norms, the exchange rate tracks it downward with brutal speed. Turkey offers one of the clearest modern case studies of this mechanism in action.
A decade ago, one US dollar bought around 3.02 Turkish liras on average. Today, 1 dollar buys 49.96 liras, a depreciation of +1,506.6% over ten years. In the last five years alone, the pair moved +419.9%. A traveler exchanging $100 in Istanbul today receives 4,995.51 TRY, an amount of nominal cash that would have funded a luxury holiday a decade ago but now covers routine travel expenses due to domestic price increases.
What drove this divergence was monetary policy running counter to economic gravity. For several years, Turkey's policymakers kept interest rates low despite surging consumer prices. When domestic savers realized that bank deposits paid far less than the inflation rate, they dumped liras to buy dollars, gold, and durable goods. That flight from the local currency drove down the lira on the open market, confirming everyone's fears and accelerating the decline. You can track this progression through our USD to TRY converter.
| Year | Average | High | Low | Change |
|---|---|---|---|---|
| 2015 | 2.7249 | 3.0647 | 2.2817 | — |
| 2016 | 3.0243 | 3.5352 | 2.7918 | +11.0% |
| 2017 | 3.6451 | 3.9644 | 3.4043 | +20.5% |
| 2018 | 4.8398 | 7.0111 | 3.7340 | +32.8% |
| 2019 | 5.6811 | 6.1780 | 5.1919 | +17.4% |
| 2020 | 7.0259 | 8.5250 | 5.8594 | +23.7% |
| 2021 | 8.8947 | 16.77 | 6.9606 | +26.6% |
| 2022 | 16.56 | 18.72 | 13.07 | +86.2% |
| 2023 | 23.79 | 29.50 | 18.69 | +43.6% |
| 2024 | 32.95 | 35.34 | 29.45 | +38.5% |
| 2025 | 39.24 | 42.99 | 35.34 | +19.1% |
| 2026 YTD | 46.07 | 49.96 | 42.97 | +17.4% |
Change = yearly average vs. the previous year's average.
Argentina and the extreme end of currency erosion
If Turkey shows what happens when inflation runs in double digits, Argentina demonstrates the math of multi-decade currency deterioration. The Argentine peso has experienced persistent, triple-digit price increases that forced wholesale repricing across every sector of the economy.
Back in late 2008, one dollar traded for 3.3955 Argentine pesos. Today, the rate sits at 1,531.52 pesos per dollar, marking a staggering change of +45,210.0% over that span. Over the last 10 years alone, the pair has climbed +10,002.4%. In Buenos Aires, shops and service providers routinely update price tags weekly or daily to keep up with the peso's shrinking buying power, as shown on our USD to ARS exchange rate page.
When a currency loses value that quickly, ordinary citizens stop treating it as a store of value. Contracts, real estate sales, and major consumer purchases shift informally to hard currencies like the US dollar. Once a population begins pricing daily life in foreign currency, the link between domestic money and the exchange rate becomes absolute: every tick of local inflation forces an immediate downward adjustment in what the peso is worth abroad.
The feedback loop of imported inflation
The relationship between prices and currency values is not a one-way street. While high domestic inflation drives a currency down, a falling exchange rate turns around and pours fuel on domestic price increases. Economists call this pass-through imported inflation.
Most international commodities trade in dollars, including crude oil, industrial metals, wheat, and natural gas. When the lira or peso falls against the greenback, every barrel of imported fuel immediately costs more in local currency at the port. Transport companies must pay more to fill their trucks, power plants pay more to generate electricity, and farmers pay more for fertilizer.
Those rising input costs do not stay hidden in supply chains. Bakers raise bread prices to cover shipping and oven fuel, while retail stores mark up imported electronics and clothing. This imported inflation adds to domestic price pressure, leading workers to demand higher wages and nudging the currency down another notch. As we explore in our guide to how a strong dollar affects global trade, economies that rely heavily on foreign energy and food feel this squeeze almost instantly.
How central banks attempt to break the cycle
To break this spiral, central banks turn to their primary defensive weapon: interest rates. Raising benchmark interest rates slows inflation through two distinct channels at home and abroad.
At home, steeper borrowing rates make mortgages, auto loans, and business credit more expensive. That cools consumer spending and tempers corporate price hikes. Abroad, higher local interest rates offer international investors a better return on local fixed-income assets, provided those investors believe the rate compensates them for inflation risk. Capital inflows or reduced capital flight stabilize demand for the currency on foreign exchange markets.
Yet raising rates carries serious trade-offs. Cranking interest rates into double digits raises borrowing costs for domestic businesses, slows economic growth, and increases the government's own debt-servicing bills. If a central bank acts too late or loses public credibility, even towering interest rates may fail to stop savers from fleeing into foreign money. Stabilizing a currency requires balancing interest rates, fiscal restraint, and credible monetary policy until price stability returns.
1 USD = 49.96 TRY · mid-market rate · Full USD/TRY converter and history →
Frequently asked questions
Why does high inflation make a currency fall?
High inflation erodes the domestic buying power of money. To keep traded goods competitive against cheaper foreign alternatives, the currency must depreciate. At the same time, international investors avoid holding currencies whose real yield is eaten away by rising prices, reducing demand for that money on global exchanges.
What is purchasing power parity in simple terms?
Purchasing power parity (PPP) is an economic theory stating that identical baskets of goods should cost the same across different countries once you convert the currencies. If a basket costs $100 in the US and 5,000 TRY in Turkey, PPP implies an exchange rate of 50 TRY per dollar.
Can a weak currency cause inflation, or does inflation cause the weak currency?
Both happen simultaneously. While domestic money printing and high demand can trigger initial inflation and weaken a currency, the resulting depreciation makes imported goods like energy, food, and parts more expensive. That imported cost increases consumer prices further, creating a self-reinforcing feedback loop.
Why doesn't the exchange rate change match inflation rates exactly?
PPP works best over long horizons. In the short run, exchange rates are swayed by interest rate differentials, geopolitical shocks, commodity prices, speculative flows, and government market interventions. In addition, non-traded goods such as local housing and personal services do not compete internationally, preventing complete price equalization.