Economics of the Exchange Rate
The UK’s trade weighted exchange rate index has depreciated by twenty-five per cent over the last
fourteen months. This is a significant change in the nominal exchange rate with both demand and supplyside effects.
Extract A: Forecasts for the UK economy
Real GDP
Consumer spending
Business investment
Exports
Imports
Manufacturing output
Company profits
Unemployment
Inflation
Base rate
$/£
Euro/£
Balance of Payments
World GDP
Euro Area GDP
% change
% change
% change
% change
% change
% change
% change
Millions, JSA
% change
Per cent
Dollars per £1
Euros per £1
£billion
% change
% change
2007
3.0
3.0
7.2
-4.2
-1.6
0.5
10.1
0.9
2.3
5.5
1.99
1.36
-£39bn
2.2
2.6
2008
0.8
1.5
-3.8
1.1
1.3
-1.8
-2.0
0.9
3.6
2.0
1.48
1.06
-£28bn
3.4
0.9
2009*
-2.5
-2.5
-8.0
-3.2
-2.7
-7.0
-18.0
1.5
0.5
1.0
1.50
1.25
-£50bn
1.0
-2.0
Source: Deloitte Quarterly Economic Review, January 2009
Extract B: Sterling's fall hasn't helped trade deficit
If the weak pound was meant to provide a boost for British industry by making our manufacturers and
service providers more competitive, there is scant evidence of it so far. To the contrary, the latest figures
show a further widening in the trade deficit. In a world where it is an absence of demand and credit rather
than a lack of competitiveness which is the root cause of our economic ills, it is not at all clear that a
devalued sterling is going to help us very much.
Import prices have been rising steeply, pushing up costs for UK manufacturers at a time when there is
little demand for what they are producing. Ultimately, devaluation o the exchange rate only works in
making an economy more competitive by leading to a downward adjustment in real wages and therefore
living standards.
Source: Jeremy Warner, the Independent, Wednesday, 14 January 2009
Assignment
Using the data and your own knowledge answer this question:
Assess the argument that, given the current state of the UK economy, the advantages of a lower exchange
rate outweigh the disadvantages. (25 marks)