Explain how an appreciation of its currency is likely to affect a country’s rate of economic growth

AQA A-Level Economics Paper 2 June 2020

Explain how an appreciation of its currency is likely to affect a country’s rate of economic growth.

Exchange rates are the value of one currency in terms of another. A currency appreciation means that the price of the currency has increased. 

1. The first possible effect of a currency appreciation is a potential decrease in economic growth.
2. A currency appreciation means that exports would become more expensive and imports would become cheaper. 
3. This means that consumers and firms are likely to increase their spending on imports.
4.  Exports would also fall as they become less competitive compared to  other countries.
5. As net exports is a component of AD, aggregate demand would shift to the left.
6. The diagram shows that price level would fall from PL1 to PL2 and real GDP will fall from y1 to y2. 
7. This happens because there would be a decrease in the value of goods and services being produced.
8. Overall, there would be a decrease in the rate of economic growth.

1. It is also possible that a currency appreciation could cause an increase in economic growth.
2. This is because a stronger currency means that imports become cheaper.
3. For example, raw materials like oil and gas can be imported cheaper from other countries.
4. We can see the effect of this when higher oil and gas prices around the world cause cost-push inflation in the UK. Inflation rose to over 10% in the UK in 2022.
5. This means that firms in the UK would benefit from a decrease in costs of production such as cheaper energy bills.
6. This would cause a right shift in the SRAS curve. 
7. This suggests that there would be an increase in the value of good and services being produced, so there is an increase in real gdp from y1 to y2.
8. Firms have lower costs of production which means they can employ more factors of production and produce more at the same price level. 
9. Also the price level falls from pl1 to pl2 as firms are able to pass on the lower costs to consumers.

Overall, a currency appreciation can cause both AD to shift to the left which causes lower economic growth, and can cause SRAS to shift to the right which causes more economic growth. The overall impact depends on the timeframe and the PED of imports and exports.

It is likely that the price level would fall.

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