Question

In: Economics

If a strong currency conveys robust economic health to the rest of the world, why are...

If a strong currency conveys robust economic health to the rest of the world, why are countries concerned when their currency appreciates substantially?

Solutions

Expert Solution

Currency appreciates when its value rises in regard to the value of another currency or a “basket” of other currencies. In global trade, currency appreciation makes a country’s exports more costly for the residents of other countries if exporters in that country can raise the prices at which they sell their goods to foreign customers. In case the exporters does not increase their sale prices because of competition, their profits decline due to the production cost, which is denominated in their domestic currency, increases relative to their revenues, which are denominated in the foreign currency. When the profits reduces a lot, few firms will stop exporting, thus the volume of exports from a country experiencing currency appreciation will fall. Similarly when currency appreciates, the residents of the country will find imported goods inexpensive relative to products produced domestically, and the imports volume will increase.

To summarize when a country's home currency appreciates substantially, domestic and foreign sales decline; and margins also falls. Because of these reasons, countries are concerned when their currency appreciates substantially.


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