exchange rates
- Created by: sherlock_holmes123
- Created on: 13-06-21 14:34
Appreciation
-occurs when the value/price of one currency increases against another/all others
-CAUSES:
Increase in d of £
Decrease in s of £
depreciation
-occurs when the price/value of one currency decreases against another/all others
CAUSES:
increase in supply of £
Decrease in d of £ on forex
impact of depreciation on c/acc BOP
-current account:
X M
P
C
D
V
-value of X increase
-value of M decrease
ceteris paribus, current account deficit decreases
-makes it easier to achieve BOP equilibrium as lesser inflows on financial account make it easier to achieve BOP eq
Marshall Lerner condition
-following depreciation, current account deficit only decreases if combined PED of X and M was greater than 1
-(must be price elastic for this to decrease deficit)
-if PED of X and M are inelastic, UK current account deficit will deteriorate
-small % increase in X would be purchased but at less total value (as they are cheaper)
-no fall in M meaning value of M rises
therefore, deficit could rise
J curve effect
-depreciation in exchange rate causes deterioration of the current account in the short term (inelastic demand)
-long term, demand becomes more price elastic and the current account improves
-linked to Marshall Lerner condition
J curve short term
-fall in price of X will cause a small % rise in QD
-rise in price of M causes small % fall in D for M- value of M rises
- If demand is inelastic following a depreciation, the current account deficit will worsen
-short term: firms and consumers may have contracts requiring them to keep buying good
-higher price of M will be incentive for domestic firms to increase production, but this will take time
J curve long term
- demand for X and M will become more price elastic
- therefore, a fall in price of X will cause a bigger % rise in QD (bigger rise in value of X)
-when demand for X is elastic, the value of X rises and current account position improves
-if d for M is price elastic, there will be a bigger % fall in d for M (total spending on M falls-increase in Ad).
-contracts end or change and consumers discover alternatives, making PED more elastic
Eval of J curve
-current account depends on consumer spending and the rate of econ growth
-also depends on consumer spending in foreign countries (d for X)
-depends on inflation (depreciation can cause imported inflation which reduces the competitiveness of X)
-firms may engage in insurance policies to hedge against exchange rate movements
impact of appreciation on c/acc BOP
-current account on bop
X M
P
C
D
V
-as value of X falls and M rise the c/acc deficit on BOP will increase (ceteris paribus)
-makes it difficult to achieve BOP equilibrium, as greater inflows of finances (bigger surplus on financial account) needs to be attracted
Marshall Lerner and appreciation
-following appreciation, current account deficit will only increase if combined PED of X and M was greater than 1 (marshall Lerner condition)
-if PED of X and M are inelastic, the UK C/acc deficit may actually decrease
-same imports purchased at less total value (cheaper) and same/slight reduction in X, but inflow of currency may increase, meaning the deficit would fall
Inverse J curve effect
-even if PED of X and M are elastic in the long run, it is likel that the PED of X and M would be inelastic in the short run due to fixed contracts and imperfect information
-therefore, c/acc deficit likely to decrease in the short run before increasing in the long run (info gaps filled and contracts renegotiated), creating an inverse J curve effect
Appreciation and econ growth
-decrease due to decrease in X and increase in M (ceteris paribus)
-negative multiplier and negative accelerator may be caused, impacting growth
-following a withdrawal from the circular flow of income, through subsequent withdrawals, there is a multiplied decrease in National Income, greater than the value of the original withdrawal
-as Samuelson said that changes in investment are directly linked to NI, a decrease in injections into the circular flow (decrease in X) and increase in withdrawals (M) creates a negative multiplier- REAL GDP falls in % terms triggering an accelerator- decreases more injections (in the form of investment)- multiplier effect continues (TIME LAG)
-size of negative output gap would increase
-although unlikely (e.g. other factors influence AD and policy response, ebb and flow of exchange rates in reality) could be a danger of hysteresis if combined with a fall in confidence and paradox of thrift
-effect depends on level of spare capacity when AD decreased
Appreciation and econ growth EVAL
-if PED of X and M are inelastic then the Marshall Lerner isn't fulfilled, therefore AD may not fall and may increase
-other factors influence AD
-as imports are cheaper following the appreciation, raw materials can be purchased at a lower price, lowering the COP - beneficial to net importers
-capital equipment and tech purchased from abroad becomes cheaper (long run benefits) as according to Schumpeter, tech is a key driver of econ growth
-current account deficit may indicate a high standard of living and now imported consumer goods are cheaper living standards may rise again.
appreciation and unemployment
-cyclical unemployment increases as AD increases- as firms reduces costs they let labour go as labour is a derived demand and less labour is needed than before.
-in exporting manufacturing sector, PED will be elastic, most likely to lay off workers first
-additionally, foreign competition (and imports) in terms of manufactured goods
-negative multiplier creates an increase in cyclical unemployment
-over time a sustained appreciation may cause structural unemployment as manufacturing suffers, adding to the NRU
Appreciation and un EVAL
-financial sector will remain relatively unaffected, as this is where our comparative advantage lies (PED more inelastic due to expertise and specialisation)
-structural un unlikely to be affect unless deindustrialisation from a lack of competitiveness occurs
-those who are cyclically unemployed will become structurally unemployed (labour deskilling) which would take significant time
-UK based importers may benefit and take on extra workers
-most importing and exporting firms will not make knee jerk reactions to hiring and firing on the basis of exchange rate fluctuations
-Time lag on the J curve- fixed contracts
Appreciation and inflation
imported inflation: the price of imported goods will decrease as they are less expensive to buy from abroad
-in terms of raw materials this will reduce cost push inflationary pressure
lower domestic demand- UK exports more expensive in terms of foreign currency, decreasing demand for X
-increased demand for M, shifting spending towards M
-decrease in domestic AD, less demand pull pressure
-more incentive to cut costs: manufacturers who export see a decline in competitiveness- provide incentive to cut costs, reducing inflation
Appreciation and inflation eval
-combined with domestic turndown there could be deflationary pressure
-only desirable if inflation is below target 2%
-Exchange rate naturally fluctuates and producers may wait before altering prices to a great extent.
depreciation and econ growth
-AD would increase due to increase in X and decrease in M
+ multiplier and + accelerator may be caused, closing the negative output gap
-effect depends on level of spare capacity when AD increases
depreciation and econ growth EVAL
-PED of X and M may be inelastic, therefore AD may not rise
-other factors influence AD (policy response, higher interest rates)
-price of M after depreciation, raw materials so COP
-capital equipment and tech purchased from abroad becomes expensive, which could have negative long term FX according to Schumpeter, as tech is key driver of economic growth.
-current account surplus - however, there is a lower standard of living, M , living standards
Depreciation and unemployment
-cyclical un as AD through positive multiplier
firms employ more workers as demand for products increases (labour is a derived demand)
-if PED is elastic in the export manufacturing sector, it is most likely to increase the number of workers first- little foreign competition, few imports of manufactured goods
-positive multiplier will decrease cyclical un if there is a sustained depreciation
-NRU decreases as manufacturing improves
Depreciation and unemployment EVAL
-financial sector will be relatively unaffected as that's where our comparative advantage lies (PED inelastic, specialisation and expertise)
-UK based importers may be negatively affected and begin to lay off workers
-most importing and exporting firms do not make knee jerk reactions to hiring and firing on basis of ER fluctuations
-TIME LAG JCURVE
Depreciation and low inflation
-price of imported goods will rise as they will be more expensive to buy from abroad
-raw materials increasing will increase cost push inflationary pressure
-increasing domestic demand. UK exports are less expensive in terms of foreign currency
d for X increases
-increase in X and decrease in M means a rise in AD, more demand pull inflation
-manufacturers who export see a rise in competitiveness have less incentive to cut costs- increasing cost push inflation
depreciation and inflation EVAL
-inflation is only desirable if inflation is below target 2%
-exchange rate naturally fluctuates and producers may wait before altering prices to a great extent
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