Explain how an appreciation of its currency is likely to affect a country’s rate of economic growth. (June 2020)

Exchange rates are the value of one currency in terms of another. A currency appreciation means that the price of the currency has increased. This means that exports will become more expensive and imports will become cheaper. This meanst that people are more likely to increase their spending on imports and exports would also fall because our exports are less competitive compared to similar exports from other countries with a weaker currency. Therefore, X-M (net exports) will fall, and therefore aggregate demand will shift to the left because AD = C + I + G + (X-M).

AD LEFT SHIFT DIAGRAM

This diagram shows that price level will fall from PL1 to PL2 and real GDP will fall from y1 to y2, suggesting that there would be a decrease in the rate of economic growth.

Another impact of a strong currency is that raw materials can be imported cheaper from other countries. This means that firms in the UK can reduce their costs of production - for example, their energy bills might fall due to cheaper oil. This would cause a right shift in the SRAS curve.

SRAS RIGHT SHIFT DIAGRAM

As a result, price level falls from pl1 to pl2. This is because firms are able to produce goods and services at a lower cost and pass cheaper prices onto consumers. Also, output can increase from y1 to y2 which means that there is an increase in employment and in real GDP. This is because firms have lower costs of production so they may be able to hire more workers and this can lead a greater level of output.

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 would depend on elasticity of imports and exports.