Question

Evaluate the following statement:

"If lower exchange rate increase a nation’s exports, the government should do everything in its power to ensure that the exchange rate for its currency is as low as possible"

Answer 1

It is true that lower exchange rate can result into increase in nations exports. Since lower exchange rate results into export from that country relatively cheaper . This in turn makes the export items more competitive in foreign market . This increase in export will also lead to growth of domestic industry and greater employment generation .

However lower exchange rate resulting into increasing export comes with its own caveat . Because very low exchange rate is likely to raise the inflation level in the economy. Also lower exchange rate will make import costly ,which means imported items will be more costly . Also imported raw material and intermediate goods will become costlier , this will increase the over all cost of production for those industries which are dependent on import material as their raw material. And hence there is likelihood of increase in inflation .

Thus the optimum level of exchange rate will be preferred way forward . Exchange rate should neither be too high nor too low , It should be in equilibrium .