On review of topic of currency exchange rates in level 2, i went through a concept that higher interest rates in a country will attract outsiders to invest money in that country, thus appreciating the value of that currency.
However, as learned in level 1, my understanding was that as the flow of money increases in the market, the currency depreciates, further leading to inflation.
This understanding of mine contradicts with the current reading I am reading, because as the outsiders invest in the country, flow of money increases than before and currency should have further depreciated.
I think that the two aspects here are independent for each other. For example, if a country pursues an expansionary policy, then interest rates decrease which would not attract foreign investment, hence not appreciating the value of the currency.
Having said that, I am not really sure what you mean by “flow of money” as that could be interpreted to mean different things.
I think what you’re getting at is the difference between the impact on expansionary fiscal policy in the short run versus long run.
According to the Schweser Book 1 LOS 14.l (page 297): “Combining the Mundell-Fleming and portfolio balance approaches, we find that in the short term, an expansionary (restrictive) fiscal policy leads to domestic currency appreciation (depreciation). In the long term, the impact on currency values is opposite.”
With expansionary fiscal policy, the initial impact is an appreciation of the domestic currency as foreign investment flows into the domestic country in the short term. Over the long term, as economic growth continues in the domestic country, the foreign investment due to the low interest rates may result in inflation in the domestic country, which would result in a depreciation of the domestic currency.