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What are the Macroeconomic Effects of Currency Fluctuations?

Currency and the Exchange rate can be a difficult topic to get your head around. I found a little cheat for remembering the different impacts of weaker or stronger currencies : SPICED which stands for Strong Pound Imports Cheaper, Exports Dear. If you can remember this it becomes easier to understand the impacts of currency fluctuations.

Fluctuations will firstly affect the rate of inflation. Changes in the prices of imported goods and services has a direct impact on the consumer price index. For example a depreciation of the exchange rate will increase the price of imported consumer goods and services. Similarly a lower exchange rate makes it easier to sell overseas because of a fall in relative prices (relative to the price elasticity of demand).

A change in exchange rate can also have large impacts on levels of unemplyment in an economy. An exchange rate appreciation causes lower levels of real GDP growth because of a fall in net exports and an increase in demand for imports. (This can be shown on a circular flow diagram). Export reliant industries are  significantly more affected by currency fluctuations while businesses that operate domestically will be less affected.

A fall in currency can however create large benefits to a economy. A drop in the pound for example, is an example of expansionary monetary policy and can be used to stimulate demand and output when a country is in a recession or slump. Economists have estimated that a 1% fall in the exchange rate has the same effect as a 0.2% point cut in interest rates. 

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