Devaluation, Competitiveness and Inflation

READERS QUESTION Inflation makes exports less competitive because prices rise, but also, currency devaluation makes exports more competitive. Since devaluation of the currency and inflation are kind of coincidental (because as the currency becomes cheaper, it increases demand and also price), what exactly happens to the competitiveness of exports?

If a currency depreciates (falls in value). Then it tends to cause inflation for three reasons:

  1. Exports are cheaper. Therefore Net Exports tends to rise causing higher AD and demand pull inflation
  2. Imports are more expensive. (The £ Sterling price of imports is higher, because the currency is weaker) Therefore we get imported inflation
  3. Because UK exports become more competitive it is argued people have less incentive to cut costs.

The Effect of Inflation on Competitiveness

You are right, if UK inflation is higher than other countries, then UK goods will become comparatively less competitive. This will cause lower demand for UK exports (depending on elasticity of demand)

If a country has a higher rate of inflation then the currency will, in the long run, depreciate (fewer people buy the currency). This will help to restore the competitiveness of exports.

Therefore, there are 2 different effects occurring.

  1. Inflation is making exports less competitive
  2. The depreciation is restoring competitiveness.

The overall effect is uncertain; it depends how much the currency depreciates in response to inflation

Related

3 thoughts on “Devaluation, Competitiveness and Inflation

  1. I think two examples would help the explanation.
    Look for actual precedents.A country with high infation and another with lower inflation than its trade partners
    devalue its currency.What is ,in the short and medium term ,the effect of such devaluetions.?
    Available statistics provide the answers for your reaserch.

  2. A good example of this could be china where it has depreciated its currency Yuan to boast the exports as a result there is 6% surplus in current account. this surplus has caused a deficit in current accounts of some developed countries specially U.S.. etc… now U.S is pressurizing china to appreciate its currency to reduce its current account deficit

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