Strong Exchange Rate

Question 1

State + explain the macro effects of a strong exchange rate.

Answer 1

• Current Account: SPICED - CA position worsening - less X revenue, more M expenditure - link to AD - lower (X - M).
• Growth: lower growth.
• Unemployment: higher cyclical unemployment.
• Inflation: lower demand-pull inflation, also lower cost-push inflation - cheaper for firms to access raw materials from abroad.
• FDI: stronger exchange rate - might mean less FDI - due to it being more expensive for foreign firms to set up in market. Also, if firms do set up, X are dearer - limit profit potential.

Question 2

State + explain the micro effects of a strong exchange rate.

Answer 2

• Costs + Profitability For Firms: CoPs fall - higher profitability as a result of cheaper M. Although, if in an X industry - X are dearer - hurts profitability.
• Domestic Producer Efficiency: if X are now dearer - harder to sell X due to strong exchange rate + M are a key competitor thats now cheaper. Firms may try to boost their own efficiency (i.e. spending money to make workers more productive, tech advancements ,reducing X-inefficiency, etc) - driving C down + domestic producer efficiency up.
• Lower Prices: due to cheaper M - greater consumer surplus.
• Higher Quantity / Choice: greater access to M for consumers.