Using the data in the extracts and your economic knowledge of economics, assess the impact of a persistent current account deficit on the

Question 1

Intro

Answer 1

• The UK has a floating exchange system where the exchange rate is determined by the market. A depreciation occurs when the spot exchange rate falls.
• The UK’s macroeconomic performance is characterized by stable inflation, low unemployment, low inequality, environmental sustainability, a balanced trade balance, and high living standards.
• 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.

Question 2

Para 1

Answer 2

• 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.
• However, the increase in the cost of production due to the increase in the value of imported goods could occur.
• A graph showing the shift in the aggregate demand curve to the right indicates an increase in overall economic activity.

Question 3

Para 2

Answer 3

• The possibility of a J-curve effect exists when the current account deficit initially increases before decreasing in the long run. A depreciation can decrease the current account deficit and potentially the financial account surplus.
• This results in a slower increase in national debt and reduced borrowing. However, if credit dries up, the high national debt can become dangerous as seen in the 2008 Greek financial crisis.
• A graph showing the J-curve effect, with a temporary increase in the current account deficit before a decrease in the long run, can be drawn.

Question 4

Para 3

Answer 4

• 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.