Evaluating effects of Forex Changes on an Economy

Question 1

Effects of changes in foreign exchange

Answer 1

1. Inflation consequences
   - Cost-push inflation caused by depreciation
   - Costs of imported capital goods & factors of production rise
   - Worse impact if imports are inelastic

• Demand-pull inflation caused by depreciation
• Cheaper exports increases AD
• More expensive imports increases net AD
• Degree of inflation is determined by economy’s current point on biz cycle

2. Unemployment consequences
   - Greater unemployment caused by Appreciation
   - Exporting firms lay-off workers b/c exports are less globally competitive
   - Domestic firms lay-off workers as consumers switch to cheaper imports
3. Economic growth consequences
   - Greater economic growth due to Depreciation
   - Exports increase b/c cheaper on global market
   - More domestic consumption b/c domestic firms more competitive due to higher import prices
4. Current account consequences
   - Trade deficit of current account balance grows is appreciation
   - More imports and fewer exports
5. Foreign debt consequences
   - Increases in foreign debt due to depreciation
   - More domestic currency needed to repay foreign debt
6. Stakeholder consequences
   - Consumers – benefit from appreciation b/c lower import prices and higher standard of living

• Producers – worse off from appreciation b/c imported substitutes cheaper & exports more expensive
• Workers – worse off from appreciation b/c reduced demand for output
• Producers dependent on imported costs of production – better off w/appreciation b/c cheaper FoP
• Foreign producers – better off from appreciation b/c increased demand for imports/less global competition
• Tourists – domestic tourists travelling abroad better off w/appreciation – foreign tourists travelling in country worse off