Consider how a currency appreciation might affect national income - Essay Example

If an economy of a nation presents a favorable environment for investments that are relatively better than other nations, then the nation will experience inflow of capital. With flexible foreign exchange rates, this capital inflow will tend to increase the value of the country’s currency. Factors such as relative product prices, monetary policy, inflation rate differences and income changes influence the appreciation of a country’s currency (LIPSEY & CHRYSTAL, 2011 p 167). The effects of these factors are discussed below: Suppose that the income of major trading of a country increase to a greater margin, there will be greater increase in domestic income which is associated with increased consumption of the imported goods.

The nation’s trading partner demand for the local goods will increase; thereby the demand for local currency will exceed quantity supplied hence appreciation. Deflation is always associated with appreciation. Suppose the price levels of a nation’s commodities decreases while that of its trading partner remains the relatively stable. The local goods will seem cheap to foreigners hence increasing the demand for local goods. This will increase the demand for money hence appreciation of the local currency.

Countries that implement restrictive monetary policies will be decreasing the supply of their currency hence currency appreciation. The appreciation of a country’s currency is relative to the currencies of its trading partner. Higher rates of interest make it more attractive to save in a nation. This is because there is a better rate of return on saving accounts. Therefore there will be inflow of money in country hence appreciation of the currency. Stronger economic growth tends to cause an appreciation in the forex market.

This is so due to the fact that with higher economic growth, there is likelihood that the nation might experience increase in interest rates (DĄBROWSKI 2001, p 10).