Assess the view that a rise in the exchange rate of the pound will help to improve the UK’s macroeconomic performance
[25]
Intro:
Currency appreciation = a rise in the external value of one currency against another or basket of currencies. Appreciation
relates to a floating exchange rate system where the exchange rate is solely determined by the interplay of demand for and
supply of the currency.
Macroeconomic objectives = there are 4 macroeconomic objectives which include economic growth, unemployment,
inflation and the balance of payments. The UK government must balance these for the optimal performance of the UK
economy. For example, the UK’s target inflation is 2%, but this may create trade-offs for other objectives
D: [show an outward shift of demand for the pound causing a rise in its external value]
Supply and demand = shifts in supply and demand will have important impacts on the UK economy. Fig.1 shows the shift of
demand outward from D to D1, showing an appreciation of the exchange rate from ER to ER1. Various factors will cause
this like greater confidence and foreign direct investment.
P: Unemployment is the number of people willing and able to work but currently don’t have a job. ER has an indirect
impact as it affects the competitiveness of local firms and the cost of M goods and raw materials.
D: Inward shift of AD and outward shift of AS
P: Stronger currency means the country can buy more M goods for a reduced price so it might decrease domestic
production. Some local companies will fail to compete against the lower price of M and go out of business causing
unemployment.
E: Depends on the import share of the domestic market and marginal propensity to import. The UK has a high import
tendency. Some industries are more exposed than others to currency fluctuations e.g. sectors where a high percentage of
total output is exported and where demand is relatively price elastic. Quality vs quantity - these imported goods just
because they are cheaper, doesn’t mean people would want to buy it.
Ev: For example, financial services in the UK probably wouldn’t go out of business due to cheaper competitors. Also causes
a shift outward of AS due to falling costs of production. This could mean the firm could pass on these reduced costs onto
their consumer and stay competitive.
P: Other local firms might see opportunity of lowering costs and increasing profit by operating somewhere else. Local
labour becomes more expensive as the opportunity cost of not doing it abroad is greater.
Ev: This creates structural unemployment as Asian economies like China and India benefit from the increased labour
demand. This is what happened in Detroit where many car manufacturers found it more profitable to import or pay foreign
labour so left.
E: If the economy is in a recession, an appreciation will cause a significant fall in demand for labour and lead to
unemployment. However, in a boom an appreciation will reduce inflationary pressure and limit the growth rate without
too much adverse impact. Sticky wages mean that unemployment may not decrease in the short run and some job losses
are temporary. However, others are permanent in the long run and if the increase in M take up a permanently higher share
of the domestic market
L: An increase in unemployment may have negative multiplier effects on the economy which will affect economic growth
P: Negative multiplier effects occur when an initial withdrawal of spending from the economy leads to knock-on effects and
a bigger final fall in real GDP. Consumers have less disposable income which will reduce AD for domestic economy
E: Although people have less disposable income, imports are cheaper which means imported goods are less expensive. But
also, firms have decreased costs of production as the UK import lots of raw materials too. This means the firms can lower
their prices by passing down these reduced prices to their consumers. The size of the multiplier depends on the marginal
propensity to consume. Wealthier individuals will keep their jobs and wealth due to being higher skilled, but they also have
lower MPC. Poorer individuals working manual labour would most likely lose their jobs but have a high MPC. Therefore, a
fall in their wage would cause greater negative multiplier effects. if the appreciation is a result of improved
competitiveness, the appreciation is sustainable and shouldn’t cause lower growth
P: Inflation is an increase in the price level of a basket of selected goods and services in an economy over a period of time.
Appreciation increases imports which causes a reduction in domestic inflation. Direct effect on CPI as appreciation reduces
the price of imported consumer goods and durables, raw materials and capital goods.
E: Depends on the elasticity of demand. Also depends on the willingness of firms to pass on the reduction in costs of
production to consumers e.g. firms may increase their profit margins without reducing costs. If firms decide to absorb the
costs.
P: Reducing in cost-push inflation as imports of raw materials are cheaper.so there are decreased costs of production.
There is a reduction in demand-pull inflation as exports are less internationally competitive.
E: Consumers may delay consumption, waiting for prices to fall even further - this has a negative impact on AD and output
which negatively affects economic growth.
Ev: Could cause disinflation which is good as long as it helps the government achieve 2% inflation. Could be beneficial
during an economic boom where inflation is always quite high due to an increase in consumer confidence leading to an
outward shift in AD. However, in a recession, this could lead to deflation.
[25]
Intro:
Currency appreciation = a rise in the external value of one currency against another or basket of currencies. Appreciation
relates to a floating exchange rate system where the exchange rate is solely determined by the interplay of demand for and
supply of the currency.
Macroeconomic objectives = there are 4 macroeconomic objectives which include economic growth, unemployment,
inflation and the balance of payments. The UK government must balance these for the optimal performance of the UK
economy. For example, the UK’s target inflation is 2%, but this may create trade-offs for other objectives
D: [show an outward shift of demand for the pound causing a rise in its external value]
Supply and demand = shifts in supply and demand will have important impacts on the UK economy. Fig.1 shows the shift of
demand outward from D to D1, showing an appreciation of the exchange rate from ER to ER1. Various factors will cause
this like greater confidence and foreign direct investment.
P: Unemployment is the number of people willing and able to work but currently don’t have a job. ER has an indirect
impact as it affects the competitiveness of local firms and the cost of M goods and raw materials.
D: Inward shift of AD and outward shift of AS
P: Stronger currency means the country can buy more M goods for a reduced price so it might decrease domestic
production. Some local companies will fail to compete against the lower price of M and go out of business causing
unemployment.
E: Depends on the import share of the domestic market and marginal propensity to import. The UK has a high import
tendency. Some industries are more exposed than others to currency fluctuations e.g. sectors where a high percentage of
total output is exported and where demand is relatively price elastic. Quality vs quantity - these imported goods just
because they are cheaper, doesn’t mean people would want to buy it.
Ev: For example, financial services in the UK probably wouldn’t go out of business due to cheaper competitors. Also causes
a shift outward of AS due to falling costs of production. This could mean the firm could pass on these reduced costs onto
their consumer and stay competitive.
P: Other local firms might see opportunity of lowering costs and increasing profit by operating somewhere else. Local
labour becomes more expensive as the opportunity cost of not doing it abroad is greater.
Ev: This creates structural unemployment as Asian economies like China and India benefit from the increased labour
demand. This is what happened in Detroit where many car manufacturers found it more profitable to import or pay foreign
labour so left.
E: If the economy is in a recession, an appreciation will cause a significant fall in demand for labour and lead to
unemployment. However, in a boom an appreciation will reduce inflationary pressure and limit the growth rate without
too much adverse impact. Sticky wages mean that unemployment may not decrease in the short run and some job losses
are temporary. However, others are permanent in the long run and if the increase in M take up a permanently higher share
of the domestic market
L: An increase in unemployment may have negative multiplier effects on the economy which will affect economic growth
P: Negative multiplier effects occur when an initial withdrawal of spending from the economy leads to knock-on effects and
a bigger final fall in real GDP. Consumers have less disposable income which will reduce AD for domestic economy
E: Although people have less disposable income, imports are cheaper which means imported goods are less expensive. But
also, firms have decreased costs of production as the UK import lots of raw materials too. This means the firms can lower
their prices by passing down these reduced prices to their consumers. The size of the multiplier depends on the marginal
propensity to consume. Wealthier individuals will keep their jobs and wealth due to being higher skilled, but they also have
lower MPC. Poorer individuals working manual labour would most likely lose their jobs but have a high MPC. Therefore, a
fall in their wage would cause greater negative multiplier effects. if the appreciation is a result of improved
competitiveness, the appreciation is sustainable and shouldn’t cause lower growth
P: Inflation is an increase in the price level of a basket of selected goods and services in an economy over a period of time.
Appreciation increases imports which causes a reduction in domestic inflation. Direct effect on CPI as appreciation reduces
the price of imported consumer goods and durables, raw materials and capital goods.
E: Depends on the elasticity of demand. Also depends on the willingness of firms to pass on the reduction in costs of
production to consumers e.g. firms may increase their profit margins without reducing costs. If firms decide to absorb the
costs.
P: Reducing in cost-push inflation as imports of raw materials are cheaper.so there are decreased costs of production.
There is a reduction in demand-pull inflation as exports are less internationally competitive.
E: Consumers may delay consumption, waiting for prices to fall even further - this has a negative impact on AD and output
which negatively affects economic growth.
Ev: Could cause disinflation which is good as long as it helps the government achieve 2% inflation. Could be beneficial
during an economic boom where inflation is always quite high due to an increase in consumer confidence leading to an
outward shift in AD. However, in a recession, this could lead to deflation.
