Exchange Rates:
Effect of Depreciation/devaluation
- External Price of exports (Px) falls and (Qx) rises - effect on exports revenue depends upon PED of
exports
- Domestic Price of imports (Pm) rises and (Qm) falls - effect on imports expenditure depends upon
PED of imports
How to devalue the currency
1. Monetary Policy:
- Lowering Interest Rates: Reducing interest rates can make a country's currency less attractive to
foreign investors. This can decrease demand for the currency, causing it to depreciate.
- Quantitative Easing (QE): This involves the central bank increasing the money supply by
purchasing government bonds or other assets. This increases the supply of the domestic currency,
which can lead to its depreciation.
2. Central Bank Intervention:
- The central bank can directly intervene in the foreign exchange market by buying foreign currency
and selling its own currency. This increases the supply of the domestic currency and decreases its
value.
3. Influence Market Expectations:
- Central banks or government officials can make statements or take actions that influence market
expectations about the future value of the currency. If markets expect the currency to weaken, they
may sell it, contributing to its devaluation.
In short run In long run
1. Elasticity Inelastic demand because it Elastic demand because birth
would not be easy to cancel foreigners and importers have
present orders, and find enough time to find substitutes
alternative immediately for
importers and foreigners
2. Balance of current - Large % fall in Px leads - Small % fall in Px leads
account to small % rise in Qx, so to large % rise in Qx, so
X falls X rises
- Large % rise in Pm leads - Small % rise in Pm leads
to small % fall in Qm, so to large % fall in Qm, so
M rise M falls
- X-M falls - X-M rises
3. Effect on AD (X-M) falls, leading to AD falls (X-M) rises, leading to AD rises
(see the graph) (see the graph)
4. Effect on demand-pull Fall (see the graph) Rise (see the graph)
inflation
5. Effect on national income Fall (see the graph) Rise (see the graph)
6. Effect on employment Fall Rise
7. Effect on Cost-Push If a country is importing major Imported raw materials and
inflation raw-materials and energy energy sources demand is
sources. They have to pay usually inelastic even in the long
greater amounts now and the run and therefore cost push
cost of imported materials will inflation is likely to increase in
rise leading to cost-push inflation. both short run and long run.
8. Effect on Standard of In the short-run, exchange rate In long run when PED of export
Living depreciation ends into fall in and import is elastic exchange
export earnings, rise in import rate depreciation results in rise
payments, fall in AD, national and export earnings, AD, national
income, employment, etc. income unemployment, and
Therefore depreciation of therefore improves the standard
exchange rate would reduce the of living; however, the standard of
standards believing in the short living is not only dependent on
run where demand export and above mentioned factors, and
import assumed inelastic therefore we cannot be sure
unless ceteris paribus
assumption.
9. Effect on Terms of Trade Fall Fall
10. Effect on Investment Like TOT, the effect on investment of exchange rate depreciation is
independent of the time period concerned.
- less overseas investment because it would be expensive to
buy foreign currencies, and therefore expensive to invest
overseas
- More foreign investment is in the country because foreign
investors now feel that they need less of their currency to buy
the same resources as before in the state country
11. J-Curve Effect If we plot time on X-axis and balance of trade on Y-axis, initially in the
short run when DX or DM is inelastic exchange rate depreciation
worsen the current account balance of country but later on in the long
run when DX and DM becomes elastic is courses and improved in
balance of current accounts and move into surplus surplus
12. Marshall Learner
condition According to Marche Lena conditions, for depreciation of currency
policy to be effective, for example, to generate long run outcome. It is
not necessary for export demand and impost demand to be elastic
individually. It is the combined price elasticity of demand of export and
import that will play decisive row in effectively exchange depreciation
policy according to Marshall learner condition change rate
depreciation will produce desirable outcome for example, long run
effects if
PED of exports + PED of imports > 1
Higher the combined price elasticity of demand for exports and
imports, more effective the depreciation policy would be.
13. The extent to which an More open = strong effects of revaluation
economy is open Less open = weak effects of revaluation
Effect of appreciation/revaluation
- External Price of exports (Px) rise and (Qx) fall - effect on exports revenue depends upon PED of
exports
- Domestic Price of imports (Pm) fall and (Qm) rise - effect on imports expenditure depends upon PED
of imports
In short run In long run
14. Elasticity Inelastic demand because it Elastic demand because birth
would not be easy to cancel foreigners and importers have
present orders, and find enough time to find substitutes
alternative immediately for
importers and foreigners
15. Balance of current - Large % rise in Px leads - Small % rise in Px leads
account to small % fall in Qx, so to large % fall in Qx, so X
X rise fall
- Large % fall in Pm leads - Small % fall in Pm leads
to small % rise in Qm, so to large % rise in Qm, so
M fall M rise
- X-M rise - X-M fall
16. Effect on AD (X-M) rise, leading to AD rise (X-M) fall, leading to AD fall (see
(see the graph) the graph)
17. Effect on demand-pull Rise (see the graph) Fall (see the graph)
inflation
18. Effect on national income Rise (see the graph) Fall (see the graph)
19. Effect on employment Rise Fall
20. Effect on Cost-Push if a country is importing major Imported raw materials and
inflation raw-materials and energy energy sources demand is
sources. They have to pay lesser usually inelastic even in the long
amounts now and the cost of run and therefore cost push
imported materials will fall inflation is likely to decrease in
leading to a reduction in both short run and long run.
cost-push inflation.
21. Effect on Standard of In the short-run, exchange rate in long run when PED of export
Living appreciation ends into rise in and import is elastic exchange
export earnings, a fall in import rate appreciation results in fall
payments, rise in AD, national and export earnings, AD, national
income, employment, etc. income, an employment, and
Therefore appreciation of therefore worse the standard of
exchange rate would increase living; however, the standard of
the standards believing in the living is not only dependent on
short-run where demand export above mentioned factors, and
and import assumed inelastic therefore we cannot be sure
unless ceteris paribus
assumption.
22. Effect on Terms of Trade Rise Rise
23. Effect on Investment Like TOT, the effect on investment of exchange rate appreciation is
independent of the time period concerned.
- more overseas investment because it would be cheaper to
buy foreign currencies, and therefore cheaper to invest
overseas
- Less foreign investment is in the country because foreign
investors now feel that they need more of their currency to
buy the same resources as before in the said country.
24. J-Curve Effect If we plot time on X-axis and balance of trade on Y-axis, initially in the
short run when DX or DM is inelastic exchange rate appreciation
improve the current account balance of country but later on in the
long run, when DX and DM becomes elastic, it caused an worsening
in balance of current accounts and move into deficit.
25. Marshall-Lerner condition According to the Marshall-Lerner condition, for appreciation of
currency policy to be effective (for example, to generate long run
outcome) It is not necessary for export demand and impost demand
to be elastic individually. It is the combined price elasticity of demand
of export and import that will play decisive row in effectively exchange
depreciation policy according to Marshall learner condition change
rate depreciation will produce desirable outcome for example, long
run effects if
PED of exports + PED of imports > 1
Higher the combined price elasticity of demand for exports and
imports, more effective the depreciation policy would be.
26. The extent to which an More open = strong effects of revaluation
economy is open Less open = weak effects of revaluation