Using the data and your knowledge of economics, evaluate the view that the UK should focus its monetary policy on managing the exchange rate in order to improve macroeconomic performance.

Question 1

Introduction:

Answer 1

• Define monetary policy, macroeconomic performance, and exchange rate (ER) manipulation.
• State that the UK’s macroeconomic objectives include sustainable growth, lowered unemployment, stable low inflation, reducing inequality, and a net-zero balance of payments.
• Highlight that the UK’s pound is in the floating exchange rate system, which means that its value is determined in relation to other currencies.
• State that if monetary policy is focused on managing the exchange rate, it is likely to be used to improve international competitiveness, reduce the balance of payments deficit, and increase long-run productive potential.

Question 2

P1: Improved international competitiveness:

Answer 2

• Explain how a lower ER makes UK-produced goods relatively cheaper to foreign buyers, making UK goods more competitive, and increasing their quantity sold.
• Discuss how increased sales lead to a greater requirement for increased production, creating more jobs in some sectors and decreasing unemployment.
• Highlight the multiplier effect, where GDP increases by a greater proportion due to increased investment.
• Discuss the downside, such as increased costs of production if UK companies rely on foreign goods/services, and the potential difficulty in forcing an increase in ER later.

Question 3

P2: Reduce balance of payments deficit:

Answer 3

• Define balance of payments deficit and state that the UK has had a persistent deficit for many years.
• Explain that reducing the exchange rate would aid in decreasing the deficit by making imports more expensive and exports more attractive, thus increasing net trade (X-M).
• Discuss how this is a component of AD, which would shift to the right, leading to higher national output and GDP.
• Evaluate whether clearing the BoP deficit is a valuable policy to strive towards, as suggested by MMT, and whether it negatively impacts the UK economy.

Question 4

P3: Reducing ER will make FDI into the UK cheaper:

Answer 4

• Define FDI and state that reducing the ER makes it cheaper.
• Explain how this leads to more job creation, as well as a multiplier effect that increases GDP.
• Discuss the potential downside of profits being extracted outside the country and foreign firms having low loyalty to UK branches, leading to withdrawal of investments or branch closures.
• Highlight the importance of the UK economy not becoming dependent upon FDI.

Question 5

Conclusion:

Answer 5

• Summarize the positive impacts of ER manipulation, including increased productive capacity, international competitiveness, and decreased unemployment.
• Evaluate whether focusing on ER manipulation neglects inflation targets and whether the potential downsides of high inflationary pressure need to be weighed against the positives of ER manipulation.
• Discuss that in times of high inflation, ER manipulation could be a viable focus for monetary policy.
• Conclude that ER manipulation can be beneficial to the UK economy, but it is not the best policy if stability is the major priority.

Question 6

What is Monetary Policy?

Answer 6

Monetary policy involves changes in interest rates, the supply of money & credit and exchange rates to influence the economy

Question 7

What is Macroeconomic Peformance?

Answer 7

The overall performance measured by changes in output, investment, prices, jobs, trade and living
standards and also the distribution of income and wealth.