Economics · The international economy · 9 marks
The pound depreciates by 10% against the currencies of the UK’s main trading partners. Explain the likely effects on the UK current account and on inflation. [9]
Mark scheme
- Depreciation makes exports cheaper in foreign currency and imports dearer in sterling
- Export volumes rise and import volumes fall, other things equal
- The current account improves only if the Marshall–Lerner condition holds: PEDx + PEDm > 1
- In the short run demand is inelastic, so the value of imports rises first — the J-curve effect
- Dearer imported raw materials and energy raise firms’ costs, shifting SRAS left
- This causes cost-push inflation
- Higher net exports also raise AD, adding demand-pull pressure if the economy is near capacity
- Evaluation: the size of the effect depends on elasticities, spare capacity and the share of imports in production
- Judgement: likely a modest improvement in the current account over time, at the cost of higher inflation in the short run
The J-curve and Marshall–Lerner are what lift this from a description to an analysis. Both named explicitly is usually worth two marks on their own.