• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Between 1995 and 1997 the effective exchange rate of the pound sterling appreciated by 20%. What factors might explain this increase in the value of the pound?

Extracts from this document...


5. Between 1995 and 1997 the effective exchange rate of the pound sterling appreciated by 20%. (a) What factors might explain this increase in the value of the pound? There are several reasons that contribute to the appreciation of the pound. INTEREST RATES Interest rates have a large effect in a world where financial capital can move freely between countries. If for example the UK interest rates are high relative to elsewhere this attracts inflows of money into the UK seeking to take advantage of the high interest rates. This "interest differential" boosts the demand for the currency and can cause its value to rise. ECONOMIC GROWTH Countries experiencing a rapid economic growth often find that their exchange rate is strengthening. Traders in the currency markets may take the rapid growth to be a sign of general economic growth and "mark up" the value of the currency as a result. Also economies with strong "export-led" growth may see their currency's rise in value. Japan is a good example of this in recent years. The Euro was weak during the first six months of its existence in part because the financial markets were worried about the slow growth of the European economy and the persistently high level of unemployment. ...read more.


MARKET SPECULATORS Special factors (such as political events, changing commodity prices etc.) can have an effect on a currency. In addition the power of market speculators has grown. When speculators decide that a currency is going to fall in value, they sell that currency and buy ones they anticipate will rise in value. It is difficult for government's to offset the power of speculators because their reserves of foreign currencies are very small compared to daily turnover in the market. We saw in 1997 and 1998 speculative attacks on currencies in Asia and seven years ago, the pound was forced out of the European exchange rate mechanism because of speculative selling of the pound. (b) Examine the likely effects of this increase in the value of the pound on the UK economy Changes in the exchange rate can have a powerful effect on the economy - but these effects take time to show through. There are time lags between a rise or a fall in the exchange rate, and changes in variables such as inflation, GDP and exports & imports. ...read more.


The strength of sterling in the last five years is one of the factors highlighted when economists analyse the north-south economic divide in the UK Many business organisations have identified the strength of the exchange rate as a major economic problem over recent times. Economists working for the ITEM club argued in the summer of 2001 that the pound should be lower by at least 10% in order to prevent manufacturing industry falling into an economic slump. However it should be noted that business can adapt to a high exchange rate. There are ways in which industries can adjust to the competitive pressures that a strong pound imposes. Some of the options include: * Cutting export prices (lower profit margins) to maintain competitiveness and market share * Out-sourcing components and raw materials from overseas * Seeking productivity / efficiency gains to keep unit labour costs under control * Investing resources in new product lines where both domestic and overseas demand is more price inelastic and less sensitive to exchange rate fluctuations. This involves producing products with a higher income elasticity of demand, where non-price factors are more important in securing orders. * Moving production overseas ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our GCSE Economy & Economics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related GCSE Economy & Economics essays

  1. What might cause an appreciation of a floating exchange rate? Discuss whether an appreciation ...

    Mere speculation can cause an appreciation of a country's currency. If speculators think that the value of a currency is about to rise, they will start buying that currency. This in turn will increase the demand and actually cause the currency to appreciate.

  2. An Empirical Investigation into the Causes and Effects of Liquidity in Emerging

    As the bonds became more illiquid, liquidity in the US high-yield index improved considerably. This implies that over time (in the long-run) liquidity of the two bond indices will offset one another so that they will always revert back to a mean overall level of liquidity.

  1. China or India? Many companies ask themselves this question. Due to saturated markets, increasing ...

    There is a huge wealth disparity. An example is Phillips that had established a plant in China and also hoped to market its product in China. But soon it discovered that even its employees could not afford it to buy the products.

  2. Contrasting Economic Value Systems in Anton Chekhov's The Cherry Orchard

    Gayef, however, still maintains a blind hope in this alternative - refusing to accept the hopeless reality of their situation. Their reluctance of leasing the property may also be understood when considering the structure of the former economic system in Russia.

  1. Explain the various factors that would lead to an increase in the size of ...

    However depreciating the exchange rate in the short run would not decrease the deficit on the Current Account in fact it would do the opposite this is because companies may be locked into contracts with companies over seas and also it takes time for people to change their spending patterns

  2. The Study of Japan's Recessions and Booms: An Analysis of Japan's GDP for the ...

    The relationship between these variables is as follows: y =1/my[M/P] + (mr/my)r my,mr > 0 2 (2) Net increases in any of the above variables will cause outward shifts of the LM curve in Figure 2. This figure is a basic IS-LM diagram with interest rates (r)

  1. Consider the advantages and disadvantages of a sharp rise in the pound upon different ...

    Public limited companies may use the opportunity to pay dividends to share holders ensuring their loyalty to the company, to maintain share prices and have potential capital that may need to be raised when the pound has fallen. Firms will be able to retain more profits in case the pound

  2. To what extent has Labour economic policy since 1997 been consistent with Tory ideas ...

    In the area of fiscal policy, Labour has moved closer even closer to their Tory predecessor, in order to shake off the 'high tax and high borrowing' reputation they earned in the 70's, which can be inflationary, and wasn't going to win them any votes in the city.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work