What impact on economic performance of the UK might the fall in the value of the pound against the Euro have been between 2000 and 2007?
What impact on economic performance of the UK might the fall in the value of the pound against the Euro have been between 2000 and 2007? An exchange rate is the price of one currency expressed in terms of another. In particular, changes in the exchange rate can change the performance of an economy by causing a shift in the economy’s Aggregate demand levels. A fall in the UKs exchange rate is likely to increase both inflation and output however will reduce unemployment within the UK and lead to an improvement in the economy’s current account. If the UK suffers a fall in its currency against the Euro it’s likely to increase exports but reduce import levels. Overall, the UKs currency in a floating exchange rate system is determined by the forces of demand and supply, where changes to this system affect the performance within the UKs economy. Between the years of 2000 to 2007, the UKs fall in the value of the pound against the Euro meant that the UKs inflation levels increased as a consequence of the rise in aggregate demand of exports against decreasing import levels. A change in the exchange rate directly affects the prices of the things the UK imports. For example, if the UKs sterling depreciates, or loses value against other currencies, such as the Euro, then the price of goods imported becomes relatively more expensive within the UK. An increase in the price of imported goods and services, will contribute to increases in inflation. On the other hand, Exchange rate movements also have an indirect effect on inflation. If the UKs sterling depreciates then British products, (e.g. tourism) become relatively cheaper for foreigners and aggregate demand for our exports will increase. The associated increase in demand for British goods and services can contribute to spending exceeding potential output, therefore causing inflationary pressure. Aggregate demand will tend to rise as exports become more price competitive and imports less price competitive.