If a currency is worth less compared to other currencies, there is an effect on prices and also the costs of goods and services a country usually imports. A lesser exchange rate raises prices of imported products.
For example, the Ugg boots mentioned in the article is a US-manufactured good; hence they are priced in US dollars. A depreciation of the dollar exchange rate will cause the imports of Ugg boots to be more expensive for British buyers. The amount by which the exchange rate of the US depreciates depends on the elasticity of the demand and supply curves.
A rise in costs of imports, as shown below, will cause the short run aggregate supply curve to proceed inwards. The diagram below emphasizes this, showing a shift from SRAS1 to SRAS 2. There lies a strong risk of inflation through this factor; people will begin asking for higher wages in an attempt to save from harm their real incomes. This can have an unconstructive outcome on competitiveness and demand for exports. Higher import costs will inevitably cause this wage-price response.
The governor of the Bank of England stated that such rates of exchange create ‘great currency tension’. Such tension could hurt the dollar further; countries such as China, baring the largest reserves of American currency outside the United States, see their dollar reserves sink in value and hurry to move them to other currencies.
Nevertheless, the US’s depreciating currency may not be completely de-grading. It can prove to be a positive trait for unemployment; it should to lead to elevated levels of aggregate demand, frequently through a rise in exports of goods and services. If exports react healthily to a more competitive exchange rate, this can lead to the growth of real national output.
The diagram above displays the effect of a depreciation of the US dollar on the balance of payments on current account. In the short term, the balance of payments worsens as the deficit grows. This is also referred to as the J-curve effect. After a while, however, the situation improves as the deficit decreases and moves towards surplus. In a longer time period, once consumers have adjusted to changes in import and export prices, the amount of US exports and imports will alter. The amount by which they change will determine the effect on the balance of payments on current account. The extent to which they change will depend upon the price elasticity of demand for US imports and exports.
