3.1.5 Impact of exchange rate changes

Question 1

current account balance of payments

Answer 1

Provides info on trading activities and income from abroad (import>export = trade deficit and vv)

Question 2

what is in a balance of payments record

Answer 2

• Current account records all payments for imports and exports, whether visible or invisible, plus inflows and outflows of income from investments
• Capital account and financial account covers all FDI and financial transactions
• Depreciation makes exports more competitive and can lead to a current account surplus when exports are selling well
• Opposite happens whn there is appreciation

Question 3

economic growth and trade deficit

Answer 3

• If the economy is growing there may be an increased demand for imports
• AD will be strong and exporters may be able to sell most of output in home market
• Little incentive to seek markets abroad
• May lead to less exports with more imports, leading to a current account deficit

Question 4

how to balance trade deficit

Answer 4

• Deficit can be balanced by FDI or financial transactions
• If withdrawals exceed injections, exchange rate will be pushed downwards and there will be depreciations
• Will make exporting more profitable and provide an incentive to exporters (WPIDEC)
• Imports dearer and consumers will look for cheaper domestic substitutes

Question 5

trade surplus exchange rate and AD decreasing

Answer 5

• Low income
• Fewer imports deamdned
• Businesses try to increase exports
• Current account surplus develops
• Exchange rate appreciate and SPICED
• Depends on Price elasticity of demand
• Are there close substitutes in domestic market/abroad that are cheaper

Question 6

export growth and increasing jobs

Answer 6

• Export growth increases jobs
  Import growth reduced demand for domestic products and reduced employment
• In economies that trade, consumers can buy from producers with competitive advantage and lower prices
• More money to spend on other things like local eateries etc that need to employ more people
• Businesses can buy inputs from cheaper sources → cuts production costs and prices, increases competitiveness and demand for their products and employment
• Businesses that cannot compete may make some employees redundant, close down be taken over etc → rationalisation leading to redundancy
• Competitive businesses recruit more people in comparison

Question 7

businesses, efficiency and structural unemployment

Answer 7

• To keep employment opportunities it is necessary for businesses to strive for efficiency
• Structural change → hurts people with low skills/obselete skills
• Changes in exchange rates alter competitiveness and shift demand patterns affectecting employment

Question 8

rate of inflation and exchange rates

Answer 8

• Inflation → rising prices and loss of competitiveness
• Imports look cheaper than rival domestic products
• Raising interest rates may help to control inflation
• If not exchange rate will fall
• Will be depreciation as demand for exports falls and demand for cheaper imports rises
• Depreciation restores export competitiveness but raises import prices
• Raises inflation rate especially if demand for some imports is price inelastic

Question 9

FDI and exchange rates

Answer 9

• Creates demand for currency of destination economy
• Increases exchange rate in short run
• If FDI is invested in facilities to produce goods fior export, in long run exchange rate will increase further as exports are made
• Appreciate may make many producers less competitive

BUT
- FDI has potential to increase employment and incomes in destination economy
- May encourage spending on consumer goods, that may be imported
- Higher imports pushes exchange rate down in long run

Question 10

time lags and exchange rates

Answer 10

• Rising import prices occur quickly → 4-6 months after sharp fall in exchange rate
• Exports rise slowly, most buyers will have already ordered their requirements for at least six months
• Full benefits of enhanced export competitiveness will take around 18 months or more to emerge

Question 11

the eurozone

Answer 11

• Single currency takes away needing to pay in foreign currency
• Reduces cost of financial transitions between countries
• Members have a fixed exchange rate for all their trade with eachother
• If any country becomes less competitive due to inflation, export sales will fall

To solve
- Businesses that export cut costs which may lead to reduced salaries
- Govs can implement contractionary economic policies (tax rates, interest rates increase)
- Both will decrease incomes