Tag: depreciation

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Plummeting Pounds

The pound is regarded as an international currency. However, the financial crisis has caused the value of the pound to fall, reaching a four-month low against the euro in September. This recent weakening of sterling is partly the result of worries that the Lloyds Banking Group will find it difficult to meet the ‘strict criteria to leave the government’s insurance scheme for toxic banking assets’ set for it by the Financial Services Authority.

However, one of the main reasons relates to recently published figures showing UK debt (see for data). The UK’s public-sector net borrowing has now reached £16.1bn and the government’s overall debt now stands at £804.8bn: 57.5% of GDP. This represents an increase of £172bn in the past year. Over the longer term, this is unsustainable. The government could find it increasingly difficult to service this debt. This would mean that higher interest rates would have to be offered to attract people to lend to the government (e.g. through bonds and bills), but this, in turn, would further increase the cost of servicing the debt. Worries about the potential unsustainability of UK govenrment debt have weakened the pound.

But isn’t a lower exchange rate a good thing in times of recession as it gives UK-based companies a competitive advantage over companies abroad? The following articles consider UK debt and the exchange rate.

Pound plumbs five-month euro low BBC News (21/9/09)
Market data Telegraph (22/9/09)
Pound slides back against dollar and euro Guardian (21/9/09)
Pound drops as UK stocks fall for first time in seven days Bloomberg (21/9/09)
Public sector borrowing soaring BBC News (18/9/09)
Govt spending cuts ‘could help pound’ Just the Flight (21/9/09)
Pound dips to four month euro low BBC News (18/9/09)
Weak pound hits eurozone holidaymakers Compare and save (21/9/09)

Questions

  1. What is the relationship between public debt and the value of the pound? How do interest rates play a part?
  2. What is quantitative easing and has it been effective? How does it affect the exchange rate?
  3. What are the advantages and disadvantages of a freely floating exchange rate relative to a fixed exchange rate?
  4. If the UK had joined the euro, do you think the country would have fared better during the recession? Consider public debt levels: would they have been restricted? What would have happened to interest rates? What would have happened to the rate of recovery
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Britain’s widening trade gap

The November 2008 trade statistics have just been released and they show that the UK had the largest nominal trade deficit on record at £8.3 billion (up from 7.6 billion in October). This represents nearly 7 per cent of GDP, the highest since 1974.

Trade gap widens despite pound’s slump Independent (14/1/09)
UK trade deficit hits a record as weak pound fails to help Telegraph (13/1/09)
Britain’s trade deficit widens to new record Guardian (13/1/09)
UK Trade, November 2008 National Statistics (13/1/09)

Questions

  1. Why has the UK’s trade gap widened?
  2. How can the concepts of income and price elasticity of demand be used in analysing the causes of the widening deficit?
  3. Explain how these elasticity values are likely to differ in the short and long run.
  4. Explain the factors that will determine whether the trade gap will widen or narrow over the coming months.
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Demanding exports

The article below is an economic briefing from The Times, published to support the Bank of England’s Target 2.0 competition. It considers the importance of the exchange rate in determining the demand for imports and exports and therefore the impact that exchange rate changes are likely to have on aggregate demand.

Economic briefing: exchange rate is crucial to export demand and influences inflation Times Online (20/10/08)

Questions

1. Explain how import prices and export prices change in response to a fall in the value of sterling.
2. Define the terms (a) price elasticity of demand for imports and (b) price elasticity of demand for exports.
3. With reference to your answers to questions 1 and 2, assess how the balance of payments will change in response to a fall in the value of sterling. What is the relevance of the Marshall-Lerner condition to these changes?