An Empirical Investigation of the Relationship Between Exchange Rate

Inflation became one of the most important economic problems in the 1970’s. Governments’ efforts to achieve a high economic growth rate was accompanied by high inflation rate. Moreover, exchange rate, more than before, seemed to be a key factor and an important element in economic policies. Furthermore, the degree to which fluctuations of exchange rate influence inflation and how the fluctuations are influenced became a common economic issue. Thus, it is necessary to investigate the relationship between exchange rate and inflation. The aim of this article is to investigate the rise in inflation of exchange rate and its magnitude. The following research hypotheses were designed for this (1) Exchange rate flactuations have inflation raising impacts. (2) Inflation results in fluctuations in exchange rate. (3) The magnitude of the effect of exchange rate on inflation vary with respect to different price indices. As far as the Iranian economy is concerned, these hypotheses were tested for the period 1338 until 1378 by using statistical and econometric methods, an appropriate model and two scenarios, one with the yearly time series data and the other monthly time series data. All variables, monthly or yearly were evaluated in Rial, and the data were gathered from Plan and Budget Organization and the bulletins of the Iranian central bank (Bank-e - Markazi).The study was conducted through library research method. The results showed that market exchange rate has positive influence on inflation, but its magnitude varies with respect to different price indices. Moreover, inflation resulted from imported goods, has positive impacts on exchange rate, but domestic inflation has influence on exchange rate only when the rate is high. Finally, based on the obtained results some suggestions were made.