Exchange Rate | Model Answer
A-level Economics
Assess the view that a rise in the exchange rate of the pound will help to improve the performance of the UK economy. (25 marks)
Here is a question and answer from the exchange rate section of the A-level Economics syllabus.
This question is an ‘assess’ question - the type of question students need to practice their exam technique. In some exam boards, this is the ‘25 marker’.
I have seen so many capable students drop a few marks on these sorts of questions simply because they do not evaluate the scenario with enough scope.
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Assess the view that a rise in the exchange rate of the pound will help to improve the performance of the UK economy.
The question asks you to provide an assessment about why an increase in the exchange rate might improve an economy’s performance. This might seem counter-intuitive at first, but nonetheless, you will need to provide reasons why it might improve macroeconomic performance and reasons why it might not. Then you need to look at the grey areas in your evaluation to explain the conditions when rising exchange rates may or may not improve performance.
Definitions
The exchange rate can be defined as the price of one currency in terms of another.
Macroeconomic performance can be measured by the four main macroeconomic indicators (Inflation, Unemployment, Balance of Payments, Economic growth)
Arguments
Describe the UK’s desired inflation rate
How exchange rate might increase imports
How inflation might improve as a result of imports rising
What the effect might be in case of boom and recession
Would there be a risk of deflation?
Could exchange rate affect cost-push inflation via SRAS?
What might be the case for UK exporting businesses?
Define unemployment
Why might unemployment increase when exchange rates rise?
Explain the type of unemployment this causes e.g. cyclical, structural, frictional, seasonal
When might unemployment be good and bad during different phases of the business cycle
Define economic growth
How do higher exchange rates affect economic growth?
How might the multiplier effect come into play when exchange rates increase and net exports decline?
Would the economy’s position in the trade cycle matter e.g. output gaps? How?
What policy responses might there be in case of negative effects on the economy?
Define balance of payments and current account
Explain why the current account may worsen
What might the benefits and costs be for the economy of a worsened balance of payments position?
What other factors are there to consider e.g. government efficiency, J-Curve effect, product dependency, elasticities, magnitude of the increase in exchange rates?
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