Globalisation - How important is the value of currency

Question 1

What is exchange rate

Answer 1

The value of a currency compared to another

Question 2

What can influence exchange rates(2+2)

Answer 2

Inflation
-If inflation in the UK is lower than elsewhere, then UK exports will become more competitive and there will be an increase in demand for Pound Sterling; also foreign goods will be less competitive and so UK citizens will supply less Pound Sterling

Interest Rates
-If UK interest rates rise it will become more attractive to deposit money in the UK, Therefore demand for Sterling will rise causing an increase in the value of the Pound

Question 3

Describe the economic effects of a devaluation of the currency(5)

Answer 3

Exports Cheaper
-exports are more competitive and appear cheaper to foreigners. This will increase demand for exports

Imports more expensive
-With the price of imports rising, this will reduce demand for imports.

Increase domestic aggregate demand causing increased economic growth

Inflation
-likely to occur because: domestic aggregate demand is increasing; with exports becoming cheaper, manufacturers may have less incentive to cut costs and become more efficient

Improvement in the current account of balance of payments

• Because quantity of exports are increasing and imports are falling
• The impact of a devaluation depends on elasticity of demand - current account only improves if demand for exports and imports are elastic

Question 4

Describe the economic effects of an appreciation of the currency(6)

Answer 4

Exports more expensive, therefore less UK exports will be demanded

Imports are cheaper; therefore more imports will be bought.

A fall in domestic demand, causing lower economic growth.

Lower inflation because: Lower domestic demand; exporters have more incentives to cut costs as the export prices are higher

Current account deficit will tend to deteriorate

• since quantity of exports decrease and imports increase
• The impact of an appreciation depends on elasticity of demand - current account only deteriorate if demand for exports and imports are elastic

Question 5

Evaluate the economic effects of an appreciation of the currency(2)

Answer 5

In a period of high growth and high inflation, an appreciation may help reduce inflation.

In a recession an appreciation is likely to lead to lower growth and higher unemployment.