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The Implication of Failed Exchange Rate

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The Implication of Failed Exchange Rate

The consequences of real exchange rate fluctuations for economic growth have drawn

increasing attention in the current policy debate since they are a significant relative price that has

an impact on the economy through a variety of routes. One of the primary causes of the growing

focus on the effect of exchange rate on production and exports is the increase in successful

strategy that has been implemented to maintain export-led growth that would lead to a stable

exchange rate policy (Ahmed Hannan et al., 2015). The second aspect is the financial impact of

exchange rate changes, which mostly affects private sector balance sheets because of the

growing dollarization of liabilities in emerging nations. According to Cooper (2019) depreciation

of the real exchange rate tends to produce losses and, as a result, a fall in economic activity since

this liability dollarization process frequently results in a currency and maturity mismatch

between the debt and revenues of the firms.

Currency exchange rates have a big impact on global relationships and trade. First off,

because FOREX curves and speculations have an impact on currency value, supply and demand

principles are evident. Additionally, cross-border transactions are made possible by the values of

several currencies. Whether a nation is better suited for exports or imports depends on how

strong its currency is (Johnston & Regan, 2016). The approach used by TH makes it easier to

comprehend possible gains from export or import activities. In this situation, a nation with a

strong currency will be ideal for imports. For instance, certain nations cannot rely on exports

due to their severe economic volatility. On the contrary, exports will benefit from the weak

currency (Guzman et al., 2018). A combination of these elements indicates that the market
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actions of businesses will be determined by the value of the currency, while a high level of

imports may exacerbate competition and harm the national economy.

According to Cooper (2019), there are significant reasons why during exchange rate

failure; manufacturers will be forced to increase export and production. The first reason is to

facilitate export growth. Foreigners have a way of knowing the economic status of the country

therefore the demand for the exports has increased due to low prices leading to a demand on it

(Johnston & Regan, 2016). Due to high demand, the country will be forced to meet the demand

by manufacturing a high volume of products that boost the economic balance of the country.

Secondly, It boosts the domestic economy- Due to an increase in the demand for exports,

manufacturers will have to increase their labor workers leading to an increase in employment.

Fourth, inflation pressures – The rate of currency exchange and inflation are closely

related. Inflation means a sharp rise in the cost of goods and services. and while the currency

exchange rate also determines the level of inflation, these changes lessen the currency's

purchasing power on the foreign exchange market (Cooper, 2019). Depreciated exchange rates

could therefore result in higher product prices, which would boost inflationary pressures in a

nation that depends on imports for consumer goods. Lastly, shift to domestic replacement-

reduction of a certain product due to increased prices limits its demand locally as the consumers

will prefer to buy a substitute of the product from another country at a cheaper price resulting in

decreased demand for the product (Guzman et al., 2018). Manufacturers can use this to produce

the product at a cheaper cheap to promote the economy of the country.

Exporting countries like the United States are discovering that increased trade prospects

come with a lower currency. That is if their monetary actions don't first spark a trade war. At
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least three major exporting nations, the United States, China, and Japan—have taken direct or

indirect steps to weaken their currencies, potentially lowering the price of their exported

commodities in other markets (Johnston & Regan, 2016). Brazil might do the same shortly.

According to Nagaraj (2021), some countries see low exchange rates as a method to boost

exports and, consequently, their overall economy. But if additional nations join the currency

devaluation bandwagon, it can backfire. As soon as everyone tries it, the move can be ineffective

and expensive. "Without the advantages of increased economic activity and job creation, one gets

the result of rising prices for goods and higher inflation (Cooper, 2019). Over time, everything

gets more expensive and one stops making money through trade.

A lower currency translates into more actual purchasing power for visitors from other

countries to the impacted country. International travelers are increasingly coming to these

nations, which raises overall demand. A weaker currency makes exporters from the affected

country more competitive in terms of pricing, provided that they choose to lower their prices

abroad rather than just raise their profit margin on each unit sold (Ahmed Hannan et al., 2015).

Increased export sales can benefit output, earnings, and planned capital investments by adding

additional money to the cycle of income and spending. Adopting a more sustainable exchange

rate is one strategy to prevent a crisis in the exchange rate. An economy faces significant dangers

from fixing exchange rates. This is especially true for emerging markets, which are frequently

distinguished by rapid capital flow and weak financial systems. A nation with a failed exchange

rate system must come up with workable measures to address the issue in order to try to ensure

exchange rate stability (Johnston & Regan, 2016).

A failed exchange rate reduces customers' real purchasing power in the affected economy.

This is due to the fact that imports, such as imported food, gasoline, and currency values, become
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more expensive when people travel abroad. For instance, according to Cooper (2019), retail

prices in the UK are today (in 2019) around 2% more than they would have been had the pound

sterling not declined in value in 2016. Imports make up about 40% of the UK's annual GDP.

Lower-income households, which spend a larger amount of their monthly budget on necessities

like food and fuel, are also more likely to be disproportionately affected by higher costs (Ahmed

Hannan et al., 2015).

In conclusion, a lower exchange rate can generally benefit the economy of a country,

although with variable results. Advantages include a positive boost to overall demand during a

period of economic instability. Encouragement for export-oriented industries to raise their prices.

Analogous to a decrease in interest rates for monetary policy. Disadvantages include Higher

consumer price inflation, which is more severe for people with lower incomes. Real income

declines have significantly impacted high street consumption and retailers and rising company

input costs have a detrimental impact on profit margins.

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References

Ahmed Hannan, S., Appendino, M., & Ruta, M. (2015). Depreciations without exports? Global

value chains and the exchange rate elasticity of exports. Global Value Chains and the

Exchange Rate Elasticity of Exports (August 11, 2015). World Bank Policy Research

Working Paper, (7390).

Cooper, R. N. (2019). Currency devaluation in developing countries. In The International

Monetary System (pp. 183-211). Routledge.

Guzman, M., Ocampo, J. A., & Stiglitz, J. E. (2018). Real exchange rate policies for economic

development. World Development, 110, 51-62.

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Johnston, A., & Regan, A. (2016). European monetary integration and the incompatibility of

national varieties of capitalism. JCMS: Journal of Common Market Studies, 54(2), 318-

336.

Nagaraj, R. (2021). Economic reforms and manufacturing sector growth: Need to reconfigure the

industrialization model?. In The Routledge Handbook of Post-Reform Indian

Economy (pp. 119-134). Routledge India.