The Effects Of An Increase In The Value Of The Euro
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Generally an appreciation is good news for EU consumers who buy from abroad.
It is bad news for exporters who will find a decrease in their profit margins.
An appreciation can help reduce inflation in the Eurozone but could also cause
lower economic growth.
1. Exports more expensive An appreciation in the EURO means the Euro
is worth more compared to other currencies like the dollar. Therefore EU exports
will be more expensive and less competitive. Therefore there will be a fall in
demand for exports. However the effect depends upon the elasticity of demand. If
demand is inelastic then there will only be a small fall in quantity demanded.
2. Imports into the EU will be cheaper. Therefore demand for imports
will increase. Again the effect depends on elasticity of demand. If demand is
elastic then there will be a big increase in value of imports.
3. Fall in Economic Growth With falling exports and rising imports
there is likely to be a fall in AD. This assumes demand is relatively inelastic.
Therefore with a fall in AD (or AD increasing at a slower rate) there will be a
fall in economic growth (Or economic growth will increase at a slower rate.)
This will also help to reduce inflation.
4. Reduce inflationary pressures. This is because:
a. Lower Aggregate Demand
b. Reduced price of imported goods.
c. increased incentive for exporters to cut costs and increase efficiency.
5. Worsening of the Current Account. The EU current account deficit is
likely to increase. This is because exports fall and imports increase. However
it does depend on the Marshall Lerner condition. This states that an
appreciation in the exchange rate will lead to a deterioration of the current
account if PED of Exports + PED of imports >1 (demand is relatively elastic)
However the effect of an appreciation in the Euro depends upon 2 things:
1. The state of the economy. If the economy is close to full capacity
then a slowdown in the growth of AD may be beneficial for reducing inflation and
growth won’t fall.
2. It depends upon other factors affecting AD. At the moment interest
rates in the EU are relatively low, therefore this is encouraging consumer
spending and therefore AD is rising despite an appreciation.
About the Author
Richard Pettinger studied Politics and Economics at Lady Margaret Hall,
Oxford University. He now works as an economics teacher in Oxford. He enjoys
writing essays on Economic and he edits an Economics Blog focused on UK and US
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Article Published/Sorted/Amended on Scopulus 2007-03-16 23:51:27 in Economic Articles