Causes of a Currency Depreciation | A-Level Economics Model Paragraph (AQA, Edexcel, OCR)

Exchange rates are the value of one currency in terms of another. Three factors that can cause a currency to depreciate are a decrease in exports, an increase in imports and a decrease in interest rates.

Exports are when money enters the economy when UK produced goods and services are sold consumers to consumers in another country. In order for someone to buy a UK export, they must first buy pounds. So, if the demand for exports falls then there would be less demand for the pound. This causes the demand for the pound to shift to the left, reducing both the price and value of the pound, from p1 to p2.

Another reason the pound could depreciate is if there is an increase in demand for imports. In order to buy imports, UK consumers must sell the pound and buy the relevant foreign currency. When consumers sell the pound, this is seen as a right shift in supply of the pound. This causes the value of the pound to fall from p1 to p2.

Thirdly, a reduction in interest rates can cause the pound to depreciate. Interest rates are the reward for saving or the cost of borrowing. If UK interest rates are cut, there will be less investors looking to save money in the UK, which means there are less hot money flows into the UK. This means demand for the pound will decrease and there will be a left shift in demand, causing the value of the pound to fall.