Sterling and the Economic Recovery

Despite a recent appreciation against the US dollar and the Euro, sterling remains well below its value of two years ago. But has the weakness of the pound - which has given the British economy a competitive boost at a time of recession - delivered the extra impetus for demand that we have been searching for? Edmund Conway considers this in his column in the Telegraph today - Weak pound might not be enough to rescue UK economy -

Car exports are looking healthier and the British economy has not see the same scale of peak to trough decline in real GDP / industrial output that countries such as Japan and Germany have suffered thus far.

But overall the British export sector seems to be taking a long time to exploit the opportunities of a competitive exchange rate. Weak demand in overseas markets has not helped; perhaps deeper supply-side weakness in non-price competitiveness is also hurting some exporters? Or have the time lags lengthened between a sizable currency depreciation and the impact on AD and an improvement in the trade balance.

The Edmund Conway article makes explicit reference to a well known concept in A2 macroeconomics - namely the J-curve effect.

“Economists talk about the so-called j-curve effect, which means that the initial months after a depreciation are often paradoxically tough for an economy. As we saw in the past year, the weak pound has kept inflation higher, and so pushed up costs for businesses, so the benefits of depreciation have not yet fed through. Likewise, it takes time for manufacturers and consumers to react to changes in currency; they do so over a course of months rather than days or weeks. The upshot is that it often takes some time before the benefits of a devaluation feed through.”

Revision presentations on exchange rates

AS Macro - exchange rates

A2 Macro - exchange rates