Assess the likely impact of an appreciation of the euro on the current account of the balance of payments for Eurozone countries

Edexcel A-Level Economics Paper 2 June 2017 Extract

Since mid-2015 the euro has appreciated. Assess the likely impact of an appreciation of the euro on the current account of the balance of payments for Eurozone countries. (10 marks)

1. An appreciation of the Euro is most likely to worsen the balance of payments for Eurozone countries.
2. Exchange rates are the price of a currency in terms of another and Figure 1 shows that the Euro appreciated from roughly £1.70 in mid 2015 to roughly £1.77 at the start of 2016.
3. As the value of the Euro increases, imports become cheaper and exports become more expensive.
4. This means that imports are likely to increase and exports are likely to fall as they become less internationally competitive.
5. As a result, the current account deficit of Eurozone countries will likely worsen as this is a measure of trade in goods and services (as well as primary and secondary income).

1. However, the impact of currency fluctuations can vary as explained by the Marshall-Lerner condition.
2. It explains that a currency appreciation is only going to lead to a worsening of the current account deficit if the price elasticity of demand for exports and imports add up to at least one.
3. It is more likely that imports and exports are actually price inelastic in demand in the short-run.
4. So, a stronger currency would actually improve the current account position as the value of exports would rise as consumers and firms abroad do not have enough chance to adjust their demand to the new prices.

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