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Currency Appreciation and Depreciation Essay

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Updated: Dec 13th, 2021

Increasing the money supply in the economy should be done with the key objective of benefiting the whole economy and ensuring that it operates at an optimum level. We should therefore exercise a lot of restraint when it comes to reducing the reserve ratio and printing more money. Increasing the supply of money in the economy will lead to the devaluation of the currency and its related consequences. Normally, increasing money supply will lead to a depreciation of the currency which might boost domestic real income, increase output and enhance the competiveness of the country’s exports; However, more often than not, it will lead to other far more adverse implications.

Increased inflation is one consequence that will occur as a result of depreciation of the currency. Inflation will lead to a reduction in the purchasing power of the country because of the increase in the price of basic commodities. Therefore, consumers will bear the brunt of this monetary policy because their paychecks will be less as a result of increased costs. Besides, it will discourage investment, especially in key instruments like bonds and currencies. It will also be hard for the country to import goods and services from other countries because of the fall in the value of the currency. In the events that these imports take place, then the consumers will suffer because the importers and producers will pass the higher costs of importation to the consumers. The “end result is a “cost-push” inflation that might trigger the possibility of a wage price spiral” ( McCallum, 1999). Hence, currency devaluation will bring about inefficiencies in the market and therefore companies might find it difficult to make long plans in terms of budgeting. The inflation will also reduce productivity of the companies as most of them will start concentrating on profits and losses as a result of currency inflation and neglect products and services.

The second reason as to why increasing money supply and the consequent currency devaluation should be discouraged is that it will lead to a reduction in foreign direct investment. Many international investors will be scared to invest in the country because of the unfavorable conditions brought about by the devaluation. They will be less willing to hold to government debt due to its low value. A reduction in foreign direct investment means that local firms will be less competitive because foreign investment encourages competition between local and foreign firms with the resultant effect of increasing the quality of goods produced as a result of the competiveness that is brought about by the FDI. Currency devaluation will also lead to a reduction in income generated by the government as a result of loss of revenues that accrue from foreign direct investment. Domestic companies are also negatively affected because they have limited opportunities from where they can explore markets and increase their incomes and profits. Besides, the opportunity to increase the level of employment to the citizens is lost.

In conclusion therefore, it is advisable that the government should not increase the amount of money circulating in the economy because of the negative consequences that will arise, key being inflation and reduction in foreign direct investments. It should instead focus on promoting other key areas like improving infrastructure, creating better incentives for investment by local and foreigners and adapting prudent fiscal policies. These actions will stimulate the economy to grow and maintain the level of money supply at an optimum level.

Reference

McCallum, T. (1999). Monetary Economics. New York: Macmillan

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