Costs and Benefits of a Weak Pound

Readers Question: What are the costs and benefits of a low pound?

A low pound means the value has fallen against others. It implies the Pound has depreciated/devalued in value.

The decline of the Pound could be due to

• Cuts in interest rates
• Declining economy – causing expectation of lower interest rates
• ‘Technical positions’ dealers selling Pounds to get rid of surplus positions.
• Loss of confidence, e.g. post-Brexit economy, financial crisis.
• See reasons for fall in value of Pound

A falling pound can indicate a weak economy and weak purchasing power; but a falling pound can give  benefits, especially in a recession.

Benefits of Low Pound

• Cheaper exports. A falling pound improves the competitiveness of UK exporters. This will lead to higher demand for UK exports (often manufactured goods). This will improve the current account deficit and increase domestic demand. . (Although, exports are an increasingly small % of the economy – manufacturing accounts for 18% of GDP)
• Increases demand for domestic products. Imports are more expensive, therefore consumers are more likely to buy UK goods, which increases UK aggregate demand.
• Recover from recession.
  
  A low pound is beneficial in times of a recession, because it is helping to increase aggregate demand. In 1992, when the UK left the ERM, the pound depreciated and this helped the economy to recover. Also, by leaving the ERM and accepting a weaker Pound, the government could cut interest rates, which helped the economy to recover
  Interest rates fell after the UK left the ERM and stopped trying to have a strong pound
  The strong Pound and high interest rates were a key factor in the recession of 1990 to 1992.
• Current account improvement. The current account deficit should improve as the value of exports rises relative to the value of imports.

Going back further in time. Leaving the Gold Standard (devaluing the currency) helped countries to overcome the Great Depression.

Costs of a Low Pound

• Imports more expensive. A weaker pounds means buying foreign goods more expensive. This means it will be more expensive for UK tourists abroad. Trips to Europe and the US will become more expensive.
• Higher costs for business. Imported goods also become more expensive. Firms who import raw materials will see higher costs, w.
• Inflation. A falling pound can cause inflation because imports are more expensive and Aaggregate Demand rises. This inflation may be just temporary or it may cause higher costs in the l0ng-term.
• Less incentive to cut costs. It is argued depreciation can make exporters have less incentive to cut costs because they become more competitive without trying.

UK inflation rose in 2011 and 2012 because of the 30% devaluation after the credit crisis. This inflation of 5% was particularly damaging because economic growth and wage growth were low. So the devaluation and higher import prices reduced living standards at a time of weak growth.

In theory, the weaker pound should have boosted exports. But because of global recession, the increase in exports was relatively modest.

Evaluation

• Basically, in a recession a falling pound is helpful, at least for the short term. However, if the economy was already experiencing inflation, then a devaluation would make inflation even worse.
• It depends why the Pound falls. If it is because of a loss of confidence in economy, then this could lead to balance of payments crisis and capital flows. If it is because of lower interest rates, this may lead to higher economic growth.
• Depends on elasticity of demand. If demand is highly inelastic, then weaker pound will do little to boost exports.

Winners and losers of weaker pound

To some extent, it depends on who you are.

• If you like foreign travel and purchasing imports, you will see higher costs from a devaluation.
• If you are a business exporting abroad, it could significantly increase profitability.

The long-term fall in the Pound reflects the fact the UK has lost competitiveness compared to the US.

Related posts

• Falling value of Sterling
• Winners and losers of a falling Pound

About The Author

Tejvan Pettinger

Tejvan Pettinger. Author of “Cracking Economics” “What Would Keynes Do?” – studied PPE Oxford University (1995-99) and works as an economics teacher and writer.

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