The Case Study: The UK current account deficit and exchange rate
This case study will explain the exchange rate depreciation, discuss the likely effect of it on the deficit the trade of goods and services on the current account, the three main costs to the UK economy of a sustained current account deficit; and also the explain the reason why UK current account deficit has not decreased as expected following a significant fall in the sterling exchange rate between mid 2007 and early 2009 according to the above case.
Exchange rate depreciation
The exchange rate is the value of currencies, which determined by foreign currency market. Exchange rate depreciation is meant by a fall in the value of a currency when the currency is floating and market forces its value. It mainly affects the real economy of UK through their effects on exports and imports. The decrease in the price of sterling s in terms of HK dollars could have been generated by a slow down in global economic activity, so decreasing the demand for UK exports, or because of foreign investors lacking confidence in the UK economy and investing elsewhere. This can be seen from the graphs below. There has been a decrease in demand D to D1 for the sterling. This has led to a depreciation in the value of the sterling from $HK16 to $HK13. The quantity of the sterling traded has also decreased from Q to Q1.
Likely effect of a fall in the sterling exchange rate on the deficit in the trade of goods and services on the current account The exchange rate is the value of currencies, which determined by foreign currency market. Current account is an indicator of performance of a country. When the total exports are less than the total imports, current account will be in deficit. When there is a fall in the sterling exchange rate, it may tend to make exports cheaper to foreigners but imports more expensive to domestic customers. This can promote exports and discourage imports...
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