Assess the likely implications of a devaluation in the dollar. (12)
Should we concerned about a rapid devaluation in the dollar?
Benefits of devaluation
Economic Growth
If the dollar becomes weaker, exports become cheaper leading to an increase in demand for US exports. This can help to increase AD and improve the rate of economic growth. This may be important, because problems in the US housing market are threatening the rate of economic growth. Falling house prices are potentially reducing consumer spending, therefore, a rise in exports could help to boost economic growth and prevent any move towards a recession.
Balance of Payments.
The US has a large current account deficit (7% of GDP) therefore a devaluation will help to improve and reduce the current account deficit. However, a devaluation alone is unlikely to solve the problem. Also, there is evidence that demand for exports and imports is relatively inelastic; therefore, any devaluation will have a small impact on the value of exports and imports. It is argued that the fundamental reason for a deficit is the low levels of domestic savings and consequently high levels of consumer spending.
Inflation
A devaluation may lead to increased inflationary pressures for 3 reasons:
1) Increase in exports causes rising AD and therefore could lead to demand pull inflation.
2) Imported goods will be more expensive. American consumers would definitely experience a rise in price for many imported manufactured goods and imports of raw materials could increase costs of business.
3) It is argued a devaluation reduces the incentive, for manufacturers and exporters, to cut costs and become more efficient.
However, the impact of a devaluation depends on the state of the economy. As previously mentioned, the US economy is slowing down; therefore inflationary pressures are subdued and therefore inflation is unlikely to occur.
Showing posts with label exchange rates. Show all posts
Showing posts with label exchange rates. Show all posts
Thursday, June 7, 2007
Thursday, May 17, 2007
What Causes an Appreciation in the Exchange Rate?
An appreciation means the exchange rate (£) becomes stronger (worth more) against a basket of currencies.
Pound Sterling will become stronger if there is higher demand for Sterling, or lower supply of Sterling.
Reasons for an appreciation in the Exchange Rate
1. Increase in Interest Rates.
Higher interest rates make it more attractive to save in the UK (there is a better rate of return on saving accounts). Therefore, there will be an inflow of hot money (people holding currency in UK saving accounts). This increase in demand for sterling causes the appreciation.
2. Lower Inflation.
If the UK has relatively lower inflation than other countries, this makes UK goods more competitive against foreign goods. Therefore, there will be more demand for British goods and hence sterling. This is a long term factor which will cause an appreciation in the value of the exchange rate.
3. Increased Competitiveness of UK goods.
Increased productivity and greater competitiveness will make British goods more attractive.
4. Expectations
Speculation plays an increasing role in the determination of exchange rates. If investors feel a currency is likely to appreciate in the future they will buy now and actually make it occur. E.g. if people expect interest rates to rise the currency will rise.
5. Surplus on Current Account.
This causes an inflow of foreign exchange into the economy. Typically, a large current account surplus will cause an appreciation in the exchange rate (unless there is a similarly large outflow on financial and capital account)
6. Higher Economic Growth.
Stronger economic growth tends to cause an appreciation in the exchange rate. This is because with higher economic growth, the country is likely to see an increase in interest rates. Also higher economic growth tends to cause greater confidence in the economy. However, it depends on the type of economic growth. If the growth is led by higher consumer spending, this will cause a rise in imports which could lower the exchange rate. If growth is export led, the currency should rise.
7. Buying Domestic Currency
If China sold its US dollar assets and bought Chinese assets, there would be an appreciation in the value of the Yuan
Related
Pound Sterling will become stronger if there is higher demand for Sterling, or lower supply of Sterling.
Reasons for an appreciation in the Exchange Rate
1. Increase in Interest Rates.
Higher interest rates make it more attractive to save in the UK (there is a better rate of return on saving accounts). Therefore, there will be an inflow of hot money (people holding currency in UK saving accounts). This increase in demand for sterling causes the appreciation.
2. Lower Inflation.
If the UK has relatively lower inflation than other countries, this makes UK goods more competitive against foreign goods. Therefore, there will be more demand for British goods and hence sterling. This is a long term factor which will cause an appreciation in the value of the exchange rate.
3. Increased Competitiveness of UK goods.
Increased productivity and greater competitiveness will make British goods more attractive.
4. Expectations
Speculation plays an increasing role in the determination of exchange rates. If investors feel a currency is likely to appreciate in the future they will buy now and actually make it occur. E.g. if people expect interest rates to rise the currency will rise.
5. Surplus on Current Account.
This causes an inflow of foreign exchange into the economy. Typically, a large current account surplus will cause an appreciation in the exchange rate (unless there is a similarly large outflow on financial and capital account)
6. Higher Economic Growth.
Stronger economic growth tends to cause an appreciation in the exchange rate. This is because with higher economic growth, the country is likely to see an increase in interest rates. Also higher economic growth tends to cause greater confidence in the economy. However, it depends on the type of economic growth. If the growth is led by higher consumer spending, this will cause a rise in imports which could lower the exchange rate. If growth is export led, the currency should rise.
7. Buying Domestic Currency
If China sold its US dollar assets and bought Chinese assets, there would be an appreciation in the value of the Yuan
Related
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