Changes in the Exchange Rate and the Macroeconomy
- A fall in the exchange rate is likely to improve the currency account position of the balance of payments.
- A fall in the price of exports will result in a rise in export revenue if demand is elastic
- A lower exchange rate (by boosting exports and reducing imports) will increase AD
- If the economy was operating with spare capacity before this rise, then employment and real GDP will rise also, as more workers would be taken on to product more products for the export and domestic market.
- A lower exchange rate could put upward pressure on inflation
- One reason for this is that if a firm’s rival goods are more expensive imported rival goods, then they have little incentive to keep their prices low.
- A rise in the exchange rate is likely to increase the current account deficit.
- It is also likely to be deflationary – reducing AD, which will reduce real GDP and employment.
- An advantage of a higher exchange rate is likely to put downward pressure on inflation