Explain and show graphically the effect of an increase in the expected inflation rate on the equilibrium exchange rate, everything else held constant

What will be an ideal response?

See figure below.

When the expected inflation rate increases, the relative expected return on domestic assets is affected two ways. First, through the Fisher effect, the domestic nominal interest rate will increase the expected return on domestic assets. Second, through purchasing power parity, the future value of the domestic exchange rate will decline which will decrease the expected return on domestic assets. Since it is generally believed that the effect of the change in the expected future value of the domestic exchange rate is larger than the Fisher effect, the net effect is a lower expected return on domestic assets. This will decrease the demand for domestic assets, which will cause the current value of the domestic exchange rate to depreciate.