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How is the economy impacted by currency fluctuations?

Not only is the forex market one of the biggest financial entities of its type in the world, but it’s also amongst the most volatile and vulnerable to a raft of geopolitical and macroeconomic factors.

Of course, currency fluctuations are a natural and inevitable outcome of floating exchange rates, but there are numerous macroeconomic factors that cause further volatility and price shifts on the foreign exchange.

In this post, we’ll explore this further, while asking how the subsequent currency fluctuations impact on the economy.

The Macroeconomy and Currency – What You Need to Know

We’ve seen corporeal evidence of how macroeconomic factors impact on currency values during the coronavirus, as interest rates across the globe have been capped as part of widespread quantitative easing measures.

This type of monetary policy is designed to stimulate the national economies and minimise inflation, but it also has the impact of minimising capital inflows from overseas and foreign direct investment.

As a result of this, a nation’s currency becomes less appealing in the eyes of investors, as it continues to lose value on the international stage.

During a tumultuous 2020, we’ve also seen how geopolitical and economic conditions can impact on currency values, particularly as negative sentiment spirals and the stock index also starts to depreciate.

As the economy stalls, consumer spending and international merchandise trade also declines, further lowering currency values and directly impacting on real-time exchange rates across the globe.

Interestingly, these dwindling exchange rates can impact on trade and GDP growth over time, creating a damaging cycle of contraction and depreciation.

What are the Impacts of These Currency Fluctuations?

This cycle is a keen focus of macroeconomic study, and there’s no doubt that fluctuating currency values destabilise global economies and impacts on numerous factors over time.

For example, the type of weaker currency that has emerged in the wake of the coronavirus immediately makes imports more expensive, while stimulating exports and making them cheaper for overseas consumers.

The reverse is also true, and in this respect, currency fluctuations impact directly on merchandise trade and will influence nations differently depending on their economic setup and the structure that underpins their economies.

Of course, stronger currencies may also contribute to reduced export competitiveness, making imports cheaper and impacting directly on the trade deficits that exist between countries.

Make no mistake; this can eventually weaken previously strong currencies in a self-adjusting mechanism, causing unnecessary damage to economies and trading agreements.

From the perspective of GDP, it’s also well-known that a nation’s gross domestic product will increase markedly on the back of higher value net exports.

So, as a widespread fall in currency values (which has been widespread globally in 2020) will stimulate a higher volume of lower value exports, GDP values will continue to decline across the board.