Yesterday we discussed whether a strong currency was desirable in terms of the macro-economic objectives of an economy. I concluded that while it helps keep inflation under control it is fairly damaging to the other macro-economic objectives. But this is a fairly simple analysis and conclusion, how can we take it further?
Perhaps we need to think about whether all these economic goals are equally important?
A strong currency will reduce the costs of imports and if your country imports a lot of food and energy then a stronger currency could significantly reduce the cost of living. This is especially helpful if you are poor and struggling to pay your basic bills. It is also just nice if it helps you buy some more cheap electronics or clothing from China. Inflation is very damaging so if a strong currency helps keep it down so much the better. In addition now that your population is spending less on food and energy they may have more disposable income to spend domestically which may improve growth and employment opportunities. At the moment UK a stronger pound would be good in reducing the cost of heating, petrol and food. That would be appealing to most people.
Another factor to consider is how trade orientated your economy is. The UK is very exposed to the global economy and therefore a strong currency can really hurt its growth potential. The UK trades extensively with the US and Europe and while a strong pound may improve the standard of living in the short run it will make our firms less competitive in the longer term, limiting exports. Our food and energy bill might fall but you may also lose your job because the company you work for is losing sales due to the strong currency. A good example here is China, China is highly dependent on foreign demand for growth and employment so an appreciation of its currency would do it a lot of harm, even if it kept cost of living down. By contrast if your economy is fairly insular then a strong currency is less significant.
We should also consider the scale of the currency appreciation. If the currency has only increased marginally or it appears to be temporary then the effect on the macro economic objectives will be short lived and/or insignificant.
In summary then, before concluding that a currency appreciation is undesirable we should consider which economic objective are most important; who is going to be most effected; how significant trade and investment are to our economy; and the scales and time frame of the currency appreciation.
However, perhaps the most important point to consider when evaluating the desirability of currency appreciation is the net elasticity of imports and exports. Tomorrow I will post some comments on the two key ideas; the Marshal-Lerner Condition and the J-Curve.
If you have any questions do ask.