Evaluating Exchange Rate

Changes
Unit 14 - Lesson 3

Learning outcomes:
Evaluate the possible economic consequences of a change in the
value of a currency, including the effects on a countrys inflation rate,
employment, economic growth and current account balance.

Exchange Rate Effects

Exchange Rate fluctuations have an effect
on different parts of a countrys economy in
a positive and negative way.
These effects include:
1.
2.
3.
4.
5.

Rate of Inflation
Employment
Economic Growth
Current Account Balance
Foreign Debt

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Rate of Inflation - Cost Push Inflation

Currency Depreciation:

Currency Appreciation:

Depreciation makes imports more

expensive.
If Domestic Producers depend on imported
factors of production - causes decrease in
SRAS.
Increases Price (Inflation) - Decreases Real
GDP & Employment.
More inelastic the demand for the import the
higher rate of inflation - eg. oil.

Appreciation makes
imports cheaper.
Results in lowering
the inflationary
pressure caused by
Domestic Producers
importing Factors of
Production

Rate of Inflation - Demand Pull Inflation

Exchange Rates influence Aggregate Demand (X - M)

Currency Depreciation makes exports cheaper.
Increased exports and lower imports.
More exports than imports - increases Aggregate Demand.

Keynesian Model - if the economy is at full employment and Aggregate

Demand increases - Demand Pull Inflation is evident in the economy.
Keynesian Model - if the economy is in a Recessionary Gap - increase in
Aggregate Demand will not cause Demand Pull Inflation
Currency Appreciation:
An Appreciation in a currency will work to reduce Demand Pull Inflation.

Effects on Employment - Currency Depreciation

Currency Depreciation -- Increase in Net Export (X - M) -- Increases AD.
Recessionary Gap
Increase in AD -- Decrease in Cyclical Unemployment -- Increase in
Real GDP -- Brings economy closer to Full Employment
Full Employment
Increase in AD -- Decrease in the Natural Rate of Unemployment
temporarily -- leads to Demand Pull Inflationary Pressure

Effects on Employment - Currency Appreciation

Currency Appreciation -- Decreases Net Exports (X - M) -- Decreases AD
Recessionary Gap
Decrease in AD -- Increase in Cyclical Unemployment -- Decrease in
Real GDP -- Recessionary Gap becomes larger.
Inflationary Gap
Decrease in AD -- Increase Unemployment (economy moves closer to
NRU) -- Decrease in Real GDP -- Economy moves closer to Full
Employment.

Economic Growth - Currency Depreciation

Depreciation of a currency -- Increase in net exports (X - M) -- Increases
AD
Effect:
Increase in AD -- Increases Real output (Real GDP) -- Economic Growth
Economic Growth through currency depreciation may be short lived.
Inflationary impacts of a depreciated currency will eventually influence
Economic Growth (Demand Pull Inflation & Cost Push Inflation).

Economic Growth - Currency Appreciation

Currency Appreciation -- Decreases Net Exports (X - M) -- Decreases AD
Negative:
Country is a net exporter of goods, Currency Appreciation will be negative
due to the decrease in AD leading to increase in Unemployment and
decrease in Real GDP (output)
Positive:
Country is a net importer of goods (developing countries improving
infrastructure), currency appreciation -- imports will be cheaper -- increase in
Investment & Government Investing (C + I + G + (X -M) -- Increases AD

Foreign Debt
If Tanzania borrows money from the European Union.
Currency Depreciation

Depreciation of the Tsh in relation to the Euro will cause the amount owed to the
European Union to increase due to the Depreciation.

Currency Appreciation

Appreciation of the Tsh in relation to the Euro will cause the amount owed to the
European Union to decrease due to the Appreciation.

Issue facing many developing countries who have foreign debt in US $

Due to the Appreciation of the US $ in relation to many developing
countries currency, the debt burdent for those countrie increases.