Exchange rates and macroeconomics objectives

Effects of APPRECIATION:

Objective	Effect
Inflation	Imports CHEAPER → lower import prices, lower inflation. GOOD if inflation high.
Economic growth	Exports more expensive abroad → demand for exports falls. Imports cheaper → reduce domestic demand. Net: growth slows.
Employment	Slower export demand and import substitution → unemployment in export and import-competing sectors rises.
BoP / Current account	Exports fall, imports rise → CA deteriorates.

Effects of DEPRECIATION:

Objective	Effect
Inflation	Imports more expensive → COST-PUSH inflation pressure. Higher domestic prices.
Economic growth	Exports cheaper for foreigners → demand rises → AD up. Tourism boosts.
Employment	Export sector hiring; import substitution → jobs created.
BoP / Current account	EXPORTS UP, IMPORTS DOWN → CA improves (if Marshall-Lerner holds).

Marshall-Lerner condition (Alfred Marshall, Abba Lerner): depreciation improves the current account IF:

$|PED_{\text{exports}}| + |PED_{\text{imports}}| > 1$

I.e. the sum of (absolute) elasticities of demand for exports and imports exceeds 1.

If elasticities are too low (e.g. necessities), depreciation may actually WORSEN the CA — higher import prices on goods with inelastic demand outweigh export gains.

J-curve effect. Even when Marshall-Lerner is satisfied, the CA initially WORSENS following depreciation before improving:

• Contracts pre-set in foreign currency take time to renegotiate.
• Export and import volumes are sticky in the short run (consumers don't immediately switch).
• So the J-curve shows initial worsening, then long-run improvement.

Policy implications:

• Countries WITH inflation problems may welcome appreciation.
• Countries with TRADE DEFICITS may welcome depreciation (after J-curve passes).
• BUT exchange rates affect MULTIPLE objectives — trade-offs are unavoidable.

Real-world examples:

• Sterling appreciation in early 2000s helped contain inflation but hurt manufacturers.
• Yen depreciation (Abenomics, 2012-2020s) supported exports but raised energy import costs.
• Currency manipulation accusations against China, others — undervaluing currency to gain export advantage.

International policy coordination. When all major countries try to depreciate simultaneously ("currency wars"), the result is competitive devaluation with little net trade benefit. G20 and IMF discourage this.