An appreciation means an increase in the value of a currency. It means a currency is worth more in terms of foreign currency. e.g. If £1 = €1 An appreciation of Pound could mean £1 = €1.2
An appreciation could occur due to higher interest rates, lower inflation or improved competitiveness. See more at: Reasons for an Appreciation
Effects of an Appreciation in the Exchange Rate
- The foreign price of UK Exports will become more expensive, therefore less UK exports will be demanded.
- Imports are cheaper, therefore more imports will be bought.
- With lower export demand and more spending on imports, there will be a fall in domesic Aggregate Demand, causing lower economic growth.
- There will be lower inflation because:
- import prices are cheaper
- Lower AD leads to lower demand pull inflation.
- With export prices more expensive, manufacturers have more incentives to cut costs.
Impact of Appreciation on AD/AS
Appreciation contributes to falling AD, leading to lower inflation and lower economic growth.
Evaluation of an Appreciation
- The impact of an appreciation depends upon the price elasticity of demand for exports and imports. For example, if demand for UK exports is price inelastic (because of few alternatives) then there will only be a small fall in demand.
- The impact of an appreciation depends on the situation of the economy. If the economy is in a recession, then an appreciation will cause a significant fall in aggregate demand, and will probably contribute to higher unemployment. However, if the economy is in a boom, then an appreciation will help reduce inflationary pressures and limit the growth rate.
- It also depends why the exchange rate is increasing in value. If there is an appreciation because the economy is becoming more competitive, then the appreciation will not be causing a loss of competitiveness. But, if there is an appreciation because of speculation or weakness in other countries, then the appreciation could cause a loss of competitiveness.
For evaluation see effects of a devaluation