What happens when exchange rate falls?

A fall in the exchange rate is known as a depreciation in the exchange rate (or devaluation in a fixed exchange rate system). It means the currency is worth less compared to other countries.

  • When there is a depreciation, and the exchange rate goes down,
    • Exports will be cheaper
    • Imports will become more expensive
  • e.g. a depreciation of the dollar makes US exports more competitive but raises the cost of importing goods into the US.
  • Therefore there will be an increase in exports and decrease in the quantity of imports.
  • Domestic firms will benefit from increased sales. This may lead to job creation and lower unemployment, especially in export industries.
  • The increase in (X-M will) help increase Aggregate Demand (AD) and therefore lead to higher economic growth