Exchange Rates
International Trade & Globalisation
The effects are symmetrical: a depreciation does one thing, an appreciation does the opposite.
Depreciation (currency falls)
A weaker currency makes exports cheaper abroad and imports more expensive at home.
Effect on exports. A foreign buyer paying in their own currency now needs less of it to buy the same export, so the export is cheaper in foreign-currency terms and foreign demand for it rises.
Effect on imports. A domestic importer now needs more of the domestic currency to buy the same foreign good, so import prices rise at home and the quantity of imports tends to fall.
Effect on prices and inflation. Dearer imports raise the prices of imported goods and of domestic goods made with imported inputs, adding to imported cost-push inflation.
Effect on growth and employment. With exports rising and import-competing industries gaining market share, GDP growth tends to rise and unemployment in those industries tends to fall.
Appreciation (currency rises)
A stronger currency makes exports more expensive abroad and imports cheaper at home.
The effects are the mirror image of depreciation: export prices abroad rise and the quantity of exports tends to fall; import prices at home fall and the quantity of imports tends to rise; cheaper imports help to bring inflation down; growth in export industries slows and unemployment in those industries may rise.
Common exam question
Predicting the effects of a depreciation or appreciation
Question: Choose the likely effect of a fall or a rise in a country's exchange rate on its exports, imports, prices, jobs or current account (1 mark, multiple choice).
Set in 5 of the 13 multiple-choice papers, once as a price calculation. Fix the direction first: a fall makes the country's exports cheaper abroad and its imports dearer at home; a rise does the reverse. After a fall, exports (tourism included) sell more, so jobs rise and a current account deficit narrows, while dearer imports add to cost-push inflation. After a rise, firms buying their supplies abroad gain; exporters and firms competing with imports lose. Wrong options reverse one link or overstate it. A government pushing the currency down has the same effects.
The specimen mark scheme sets the idea for 2 marks: two reasons a government may want a lower exchange rate (more exports and fewer imports, growth, jobs, or too few reserves to defend its value).
Common exam question
Whether a rise in the exchange rate benefits the economy
Question: Discuss whether or not a rise in the value of a country's currency would be good for its economy (6–8 marks).
Asked in 2 of the 11 structured papers, once for 8 marks and once for 6 in the data question. For: cheaper imports cut firms' raw material and capital costs and add competitive pressure, lowering inflation; the country buys more imports for the same exports, widening choice; lower total demand eases demand-pull inflation. Against: dearer exports cut export sales and revenue, import spending rises and the current account worsens; lower net exports slow growth and raise unemployment. One scheme also credits confidence attracting multinationals against higher setup costs deterring them, and export revenue rising if export demand is price inelastic.
Develop both sides: the 6-mark version allows at most 4 for either side, and the 8-mark one holds a one-sided answer in Level 2 (3–5). Each point counts once: reversing a point already made scores nothing.
Consequences at a glance
| Depreciation (currency ↓) | Appreciation (currency ↑) | |
|---|---|---|
| Export prices abroad | Cheaper | More expensive |
| Quantity of exports | Rises | Falls |
| Import prices at home | More expensive | Cheaper |
| Quantity of imports | Falls | Rises |
| Inflation | Rises (imported cost-push) | Falls |
| Export-sector growth | Up | Down |
| Consumer purchasing power on imports | Down | Up |