📉 Effects of Depreciation (Weaker Currency)
When a currency depreciates, exports become cheaper for foreigners and imports become more expensive for domestic consumers.
- Exports become more competitive — foreign buyers find the country's goods cheaper → export revenue may rise.
- Imports become more expensive — domestic consumers switch from imports to domestic substitutes → import spending may fall.
- Current account improves — IF the Marshall-Lerner condition holds (PED for exports + PED for imports > 1).
- Inflation rises — imported raw materials and consumer goods cost more → cost-push inflation.
- Economic growth may increase — net exports rise (X−M), boosting AD.
- Foreign debt burden rises — debt denominated in foreign currencies becomes more expensive to repay.
Marshall-Lerner condition.
📈 Effects of Appreciation (Stronger Currency)
The effects are the mirror image of depreciation:
- Exports become less competitive — foreign buyers find the country's goods more expensive → export revenue may fall.
- Imports become cheaper — consumers benefit from lower prices on imported goods.
- Current account may worsen — cheaper imports, more expensive exports.
- Inflation falls — cheaper imports reduce cost-push pressures.
- Economic growth may slow — net exports fall, reducing AD.
- Foreign debt burden falls — cheaper to repay debt in foreign currencies.
In IB essays, always discuss both the positive and negative effects of exchange rate changes. An appreciation is NOT simply 'good' or 'bad' — it depends on the country's circumstances.
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🔄 The J-Curve Effect
J-curve effect.
- Short run — import and export volumes are relatively inelastic (contracts, habits). The higher cost of imports outweighs any volume change → current account worsens.
- Long run — consumers and firms adjust. Export volumes rise, import volumes fall → current account improves.
- The path traced resembles the letter J when plotting the current account balance over time.
The J-curve explains why a depreciation doesn't immediately improve the current account. Time is needed for trade patterns to adjust. Mention this in essays about exchange rate policy effectiveness.