IGCSE Economics - The Impact of Exchange Rates on the Current Account

Exchange rate

the relative price of one currency expressed in terms of another currency

An appreciation

• Leads to a worsening of the current account balance

A currency appreciation

• Occurs when the value of a currency rises, making a nation’s exports relatively more expensive and imports less expensive

Exports fall

foreign buyers look for substitute products which are priced lower

• exports fall, balance on the current account worsens

Imports rise

Imports cheaper

• domestic consumers may switch demand to foreign goods, and as imports rise, the balance on the current account worsens

Impact of a depreciation

leads to an improvement in the current account balance

A currency depreciation

• occurs when the value of a currency falls, making a nation’s exports relatively more attractive and imports less attractive

Exports rise

the number of foreign buyers increases as they are attracted by the relatively cheaper prices

• exports rise and the BoP on the current account improves

Impots fall

imports more expensive

• domestic consumers may switch from purchasing foreign goods to purchasing domestic goods, and as imports fall, the BoP improves

Impact of a Current Account Deficit

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Increasing unemployment

falling demand for locally produced goods and services, fewer workers will be required and unemployment will rise

Slow down in economic growth or a recession

exports are a key component of the real GDP of many countries, and a fall in exports may significantly reduce the level of economic growth

Lower standards of living

reduction in wages

Increased levels of borrowing

increasing levels of imports, likely are paid for through high levels of borrowing

Depreciating exchange rate

May ultimately help to increase exports again, makes the cost of imported goods and raw materials more expensive and may cause cost push inflation