Assess the view that a depreciation of the pound against other currencies is likely to improve the UK’s macroeconomic performance Flashcards
1
Q
Intro
A
- The exchange rate measures the external value of one currency against another currency
- The UK operates with a floating exchange rate system where the forces of market demand and
supply determine the daily value of one currency against another - An increase in supply or a decrease in demand for pounds in the foreign exchange market leads to a depreciation.
- Expansionary monetary policy also leads to a depreciation, but speculative flows have a greater effect on exchange rates.
- Changes in the exchange rate affects demand for exports and imports, real GDP growth, inflation,
business profits and job
2
Q
Negative output gap reduction
Para 1
A
- A depreciation of the pound can improve the trade balance by increasing net exports.
- With price elasticity of demand for exports greater than that of imports, there is an increase in export revenue and a decrease in import expenditure, leading to an injection into the UK economy.
- This leads to an increase in aggregate demand and a reduction in the negative output gap, potentially resulting in economic growth.
- This can be shown graphically, when there is a reduction of the output gap AD1 shifts to AD2 and Y1 shifts Y2 bring ing the economy closer to outpu gap equilibrium (YFE)
- However, the increase in the cost of production due to the increase in the value of imported goods could occur.
3
Q
Current Account Deficit
Para 2
A
- Initally, current account deficit worsens from point A to point B this is due to the low price elasticity of demand for imports and exports in the short term. So initially the quantity of imports of goods and services will remain possibl;y the same because of contracts for imports perhaps, they have been signed and they will be met. If a firm has a low price elasticity for imports you will end up spending more for imports if there is a depreciation
- Also, export demand may be initially inelastic to exchange rate change it may take time to adjust to sell more goods and services to foreign countries, it also may take time for foregin consumers to notice that a country’s exports have got cheaper.
- So initially you are spending more on imports and exporting less leading to current account deficit in UK worsening (A to B)
- Over time we move from Point B to Point C (provided that the PED for Imports + Exports is greater than 1, this is known as MLs conditions)
- However, if credit dries up, the high national debt can become dangerous as seen in the 2008 Greek financial crisis.
4
Q
Current Account Deficit - (Evaliuation)
Para 2 - Evaluation
A
- ## Depreciation of a currency unlikely to correct a current account deficit that has structural (supply-side) causes.
5
Q
FDI and economic growth
Para 3
A
- A depreciation can potentially increase foreign direct investment (FDI) as the cost of investment decreases with a comparatively stronger foreign currency.
- This leads to an increase in productivity and job creation, resulting in short and long-term economic growth. However, repatriation of profits back to the country of origin could occur.
6
Q
What is expansionary monetary policy?
A
A reduction in interest rates and/or an increase in the supply of money and credit in an economy is
called an expansionary monetary policy or a reflationary monetary policy
7
Q
What is the current account?
A
- The current account of the balance of payments comprises the balance of trade in goods and
services plus net investment incomes from overseas assets and net transfers
8
Q
What is the Balance of Payments?
A
- The balance of payments (BOP) records all financial transactions made between consumers, businesses and the government in one country with other nations
- Inflows of foreign currency are counted as a positive entry (e.g. exports sold overseas)
- Outflows of foreign currency are counted as a negative entry (e.g. imported goods and services)
