In my previous posting on
Macroeconomic Logic, I had explained how all the main four main macroeconomic
variables such as economic growth, unemployment, inflation and current account
deficit interact with one another in the most logical way. What I didn’t
mention was, there are in fact more macroeconomic variables, or to be more
precise macroeconomic objectives than you think. Three other crucial ones are
government finances, income inequality and environmental goals which I had
purposely omitted. I will add them into our discussions one at a time, so as to
minimise confusions
In this second posting, I will
introduce another two. One is government finances and another is appreciation/
depreciation of exchange rate. To make things simple, I will consider pound
sterling all the time
1. Currency depreciation vs. growth. When
the value of pound decreases, British goods will become artificially cheap.
This will most likely lead to an increase in the amount of exports. At the same
time, weak currency implies that foreign goods will now become artificially
more expensive. Imports will likely fall. The combination of these two, holding
other factors constant, will lead to a rise in (X-M). Since this is one of the
components of AD, that means AD will now shift to the right. Economic growth is
achieved as more goods/ services are produced to cater for foreigners
2. Currency depreciation vs.
unemployment. When the value of pound decreases, home-made goods will become
artificially cheap. As such, value of exports will increase. At the same time,
foreign goods will appear artificially more expensive to Britons. That leads to
lower imports. Rise in factory orders both from the international and home
market will help to rejuvenate the beleaguered manufacturing industry in the
UK. Firms will now require more manpower to produce the output. Unemployment is
expected to fall
3. Currency depreciation vs. current
account deficit. In theory, the weakening of home currency will promote international
price competitiveness. Foreigners will now perceive British goods as
artificially cheap and so, this may lead to greater exports. In contrast,
Britons will consider any imported goods and services to be artificially
expensive with the fall in pound. This discourages the consumption of imports.
Assuming other factors to be constant, a rise in inflows coupled with a decline
in outflows will overall reduce the size of the UK’s current account deficit
4. Currency depreciation vs. inflation.
The fall in the value of pound can generally lead to three types of inflation
within the UK. First, as exports become artificially cheap while imports
artificially expensive, value of (X-M) will increase. This will shift AD to the
right thus contributing to demand-pull inflation. Second, a weak pound will
indicate that imported final goods, raw materials, spare parts and
semi-finished goods are now artificially more expensive. Businesses, facing
higher production costs will normally pass this on in the form of higher price
to ensure a healthy margin of profits. Cost-push inflation is resulted.
Interestingly, if the imported goods become expensive due to relatively higher
inflation in other countries or due to weaknesses of home currency, that will
contribute to imported inflation, which is also a type of cost-push inflation
5. Currency depreciation vs. government
finances. The weakening of pound will promote the international competitiveness
of British goods. A rise in factory orders is expected to increase the margin
for factories. At the same time, unemployment is likely to fall in this key
area due to more manpower needed. If one was to consider carefully, this will
probably contribute to greater tax revenue due to higher corporate tax and higher
income tax collected. At the same time, the government is expected to pay less
in terms of Job Seekers’ Allowance as well as subsidies to prevent bankruptcy
More to come in my next posting. I
will introduce fiscal policy and monetary policy and how it works to reduce
current account deficit. On top of that, I will also show you how they can
actually create effects onto other macroeconomic variables. This is one of the
most crucial areas that is not properly introduced in CIE
No comments:
Post a Comment