Unit 4 June 2011 Essay 3 Question 12- PLAN/OUTLINE:

12) Evaluate the possible macroeconomic consequences for an economy of a rise in the exchange rate of its currency 

Introduction + Development 

  • Macroeconomic Consequences( DEF) – This would include economic growth, inflation, unemployment, balance of payments 
  • Rise in the exchange rate- meaning an appreciation in the value of the currency. E.g. £1=$2 is now £1=$2.50
  • Can have both good and bad macroeconomic consequences 

Point 1 – Appreciation would mean increase price for our exports- their domestic goods

  • This could mean a decrease in our demand for exports, which is a part of Aggregate demand( def), other things being equal it could mean a decrease in AD + Diagram

    from google images

  • This could lead to a negative multiplier effect(DEF) as other firms will be effected leading to a much bigger leakage to the economy
  • Additionally it would lead to increase of unemployment due to decrease in exports meaning firms has to cut down its costs as they be making less profit. This could be due to the multiplier effect aswell.

However 

  • However an appreciation today could mean a depreciation in the future because demand for exports will decrease causing a decrease in value of currency. So exports may rise in the future.
  • Additionally imports themselves would be cheaper and may benefit firms that are import based in terms of raw materials. This could also mean the price of some goods to be cheaper than normal. 

Point 2- Affects the Balance of Payments 

  • Balance of Payments  are a record of the financial transactions over a period of time between a country and its trading partners.
  • An appreciation would lead to exports being more expensive therefore could contribute t a balance of payments deficit. 
  • A lack of international competitiveness aswell , aswell as jobs and in the long run it could be the undermining of the standard of living. 

However:

  • Depends in the elasticity of the exports- marshall lerner condition. If the exports have a low elasticity maybe due to quality an increase in the exchange rate would be greater the level demanded for exports. 
  • Consider the capital and financial flows which tend to make up the deficit 
  • Consider how much the exchange rate has increased by

Conclusion:
The macroeconomic impacts of the value of currency increasing can affect the whole economy in terms of growth where aggregate demand is affected then potentially leading to a negative multiplier effect. However many things need to be considered as said if the exchange rate increase is only short term and only increase by a little there is no need to worry. 

 

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