The pound is regarded as an international currency, but its value has been declining throughout the financial crisis. Indeed, this downward trend is one of the factors that has prevented the recession in the UK from getting worse. As the exchange rate changes, the relative competitiveness of a country’s products changes and this therefore affects exports and imports.
However, despite a declining pound, exports from the UK have fallen and this has contributed to an unexpected global goods trade deficit in January of nearly £8 billion – the largest level since August 2008 and well above the forecast of £7 billion. This is putting further pressure on the pound. A key to the UK’s economic recovery was argued to be growth in exports, but this now appears to be a somewhat forlorn hope. The figures released show that exports slumped 6.9% to £19.5 billion in January, whilst imports only fell by 1.6%. A contributing factor might be the bad weather that hit the UK in January, but the long-term decline of manufacturing in Britain has also been put forward as a reason.
The following articles consider the UK’s trade deficit and the possibility of an export-led recovery.
Articles
January trade deficit widens as exports fall Guardian, Kathryn Hopkins (9/3/10)
UK trade gap widens to worst in 17 months BBC News (9/3/10)
Exports plunge heaps pressure on pound Independent (9/3/10)
Pound slides back against dollar and euro Guardian, Ashley Seager (21/9/09)
Trade gap widens despite weak pound Financial Times (9/3/10)
UK exports plunge by £1.4 billionThe Press Association (9/3/10)
Pound falls again on deficit fears Guardian (9/3/10)
UK trade gap widens as exports sink Wall Street Journal, Nicholas Winning (9/3/10)
Rebalancing, deferred BBC News blogs, Stephanomics Stephanie Flanders (9/3/10)
Global recovery is helping UK, says Bank of England’s Sentance Guardian, Larry Elliott (18/3/10)
Pound Declines as Investors Bet Bank of England Will Hold Rates BusinessWeek, Lukanyo Mnyanda (20/3/10)
Data
For UK balance of trade data, see UK Trade (Office for National Statstics)
For exchange rate data, see Statistical Interactive Database (Bank of England)
Questions
- How is the value of the pound determined?
- Illustrate a depreciation of the pound on a diagram. What are the factors that could cause this?
- When the value of the pound falls, why should UK goods become more competitive?
- Explain why an export-led recovery was a possibility for the UK economy. How can we use the transmission mechanisms to help explain this?
- Despite a weak pound, exports have fallen. What are the explanations for this?
- What are the consequences of a widening trade deficit and how can it be tackled?
It’s not just the roads in the UK that were frozen, as the Bank of England unsurprisingly decided to keep interest rates frozen at 0.5%. Furthermore, many economists do not expect to see interest rates increase for some time. Roger Bootle has predicted that rates could stay low for up to 5 years and this will contribute to a continuing weak pound and spell further trouble for importers and their customers.
The Bank of England also left its money-creation programme of ‘quantitative easing’ unchanged, but next month it will have to decide whether to extend quantitative easing beyond the limits of £200 billion that it set back in November.
Whilst we are supposedly beginning our economic recovery – with 2009 quarter 4 figures showing the first rise in output since the first quarter of 2008 – its strength remains questionable. Indeed, the rise in output in the last three months of 2009 was a mere 0.1%. So how important are interest rates in helping to sustain the recovery? Can they really pull us out of the recession by remaining at just 0.5%? Read the articles below which look at freezing interest rates and quantitative easing.
FTSE unaffected by interest rate decision In the News (7/1/10)
Freeze on UK interest rates BBC News (7/1/10)
Bank of England may raise interest rates as soon as March, leading economist predicts Telegraph (7/1/10)
Interest rates and quantitative easing on hold Guardian, Larry Elliott (7/1/10)
Bank of England extends quantitative easing by £25bn – but is it enough? Guardian, Larry Elliott (5/11/10)
Questions for QE BBC News blogs, Stephanomics, Stephanie Flanders (7/1/10)
Interest rates could stay low for 5 years, says Bootle BBC News (7/1/10)
Questions
- How do low interest rates contribute to a weak pound? How does this affect exporters and importers?
- What is quantitative easing? Should the QE programme be extended? What are the arguments for and against this in terms of economic recovery and public debt?
- How much of an impact do you think the recession will have on government policy over the next few months?
- Explain the transmission mechanisms by which changes in interest rates affect the goods market.
- If the Bank of England were not independent, what do you think would be happening to interest rates?
With the world economy in recession, major exporting countries are suffering more than many, especially exporters of high-quality manufactured products, many of which have a high income elasticity of demand. Germany, the world’s largest exporter, has been particularly hard hit. In the year to April 2009, the value of German exports fell by 28.7 per cent. The following articles look at the data and some of the explanations.
German exports in April 2009: –28.7% on April 2008 Destatis (9/6/09)
German exports plunge amid economic slowdown DW-World (9/6/09)
Weak German economic data dash early recovery hopes Monsters and Critics (9/6/09)
German industry output disappoints, falling 1.9 pct Guardian (9/6/09)
See also this video on the recession in the EU: EU recession ‘deeper than expected’ BBC News (15/5/09)
Questions
- Why have German exports fallen considerably more than German GDP? How can the accelerator theory help to explain the fall in German exports?
- If economic sentiment recovers in Germany, how will this affect (a) aggregate demand; (b) imports; (c) exports?
- Find out what has happened to the euro exchange rate index and assess whether movements in the euro have contributed to Germany’s export performance (see for example the Bank of England Statistical Interactive Database).
The following article from The Economist looks at the role of imports in stimulating economic development in developing countries. It questions the simple perception of many people, not least politicians, that exports are good, but imports are bad. Far from merely being a drain on the balance of payments and a threat to domestic industries, imports can provide both useful competitive pressures and access to intermediate goods.
Opening the floodgates The Economist (7/3/09)
(The paper referred to in The Economist article above)
Questions
- How can reducing trade barriers and thereby reducing the price of imports help a developing country?
- Consider whether the total removal of trade barriers would be desirable for developing countries.
- Explain what is meant by “But the Indian variant of creative destruction seemed unusually benign” and why this was so.
- Why has it proved so difficult to secure an international agreement to reduce trade barriers under the Doha trade round?
The European Commission is concerned that the economic downturn may have put the livelihoods of dairy farmers at risk. To try to prevent any problems for farmers, the Commission has re-introduced export subsidies for dairy products. The last time subsidies were paid to dairy farmers was June 2007 and the EU insists that the payment will meet World Trade Organisation (WTO) rules.
EU gives boost to dairy exports BBC News Online (23/1/09)
Questions
- Using diagrams as appropriate, illustrate the impact of the EU export subsidies on the market for milk.
- Additional support for dairy farmers comes in the form of EU intervention – European Commission purchases of surplus produce at a guaranteed price. Using diagrams as appropriate, illustrate and explain how this ‘guaranteed price’ scheme will work.
- Explain the role of the WTO in determining world trade rules.
- Discuss the likely reaction of other countries to the EU’s payment of export subsidies to dairy farmers.