Exploring the Economic Effects on Inflation, Exports, Imports, and Growth

Economic Effects

Economic Effects of Currency Movements:

Please note that the following effects occur in the case of a depreciation.

Inflation:

• A depreciation makes imports more expensive.
• Producers may pass on higher costs of imported components and raw materials onto consumers. This depends on the price elasticity of demand for the good or service in question.
• Wages may rise in response to this, triggering a wage-price spiral.
• Conversely, as inflation rises the prices of one’s exports rises:
• This decreases the demand for one’s currency.
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• Thus high inflation rates tend to decrease the value of one’s currency which tends to result in inflation.

Exports:

• Exporters should benefit from a depreciation because it makes their goods cheaper when priced in a foreign currency – therefore they will be able to sell more and the demand for their currency will begin to rise.
• The foreign elasticity of demand for one’s goods and the level of income overseas will determine the effect on the demand for exports.

  If the demand for one’s goods is quite elastic then the decrease in price will cause a proportionately larger rise in quantity demanded.

• Exporting firms may decide to hold export prices constant and take higher profits:
• These goods will therefore cost the same as before in terms of the exporter’s currency but, because the exporter’s currency has depreciated against the buyer’s currency, these goods will have become less expensive in terms of the buyer’s currency causing quantity demanded to rise.
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  Therefore, more revenue will be generated.

Imports:

• Demand for imports should fall as imports become more expensive.
• Some imports are essential for production, cannot be made locally and have an inelastic demand – therefore one ends up spending more on such items:
• This may result in imported inflation.

Balance of Trade:

• Normally, depreciation improves the Balance of Trade by reducing demand for imports and increasing demand for exports.
• However, in the short term there may be a J-curve effect, which causes the balance of trade in goods and services to deteriorate and then rise again (right):
• People need to spend more on certain imports.
• Exporters need time to increase production.

Economic Growth:

• Higher exports and falling imports lead to rising GDP levels:
• Falling imports mean that consumers are having to buy local goods instead of imported goods which means that local producers will produce more. This increases GDP levels by raising consumer demand.
• A lower exchange rate might be accompanied by lower interest rates which will stimulate consumer spending:
• A country reduces interests rates in order to promote economic growth and push it up to new levels.

A Weak Currency:

Please note that what is written below depends upon a situation in which the HKD is weak.

Advantages:

• Higher export demand as HK goods become comparatively cheaper.
• Higher export demand generates more income and output, causing economic growth as aggregate demand increases.
• Lower import levels also result in citizens having to buy from domestic firms which increases the supply from such firms causing GDP to rise.
• More tourists will be attracted to Hong Kong which has become a cheap holiday destination to come to. This generates more jobs and income through the multiplier effect.
• Exports increase, sales increase, revenue and potential profits increase.
• Higher export demand and fewer imports mean a healthy BoT.

Disadvantages:

• Imports will cost more as more HKD will be needed to buy overseas currencies. This may cause imported inflation.
• Hong Kong shoppers’ real purchasing powers will fall as they have to use more of their income to buy what they need:
• Remember depreciation of one’s currency may result in inflation.
• Speculators start selling the HKD fearing a decline in its worth and so they can buy it back at a cheaper rate in the future:
• This causes the supply of HKD to increase which results in further depreciation.
• Profits may fall because of the increase in the price of imported raw materials, capital goods and intermediate goods.