What is Currency Appreciation?

In the below-mentioned diagram, when demand for the pound increases, then the value of the pound to dollar increases from 1 pound = 1.55 dollars

1.55 dollars to 1 pound = dollar 1.65.

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Impact of Currency Appreciation

#1 – Rise in Export Costs

If a country’s currency appreciates, the number of goods exported from that country will drop. This will lower the GDP (gross domestic product), ultimately not favoring that.

#2 – Cheaper Imports

The imported goods will become cheaper in a foreign country if the domestic goods tend to become expensive on the international market. This means that a domestic currency can buy a higher value of the foreign currency, ultimately enabling the buyers to buy more international goods.

#3 – Results in Trade Deficit

It also results in trade deficitsTrade DeficitsWhen the total sum of goods or services that a country imports from other countries is higher than the total sum of goods or services that a country exports to other countries, this is referred to as a trade deficit, which is the opposite of the balance of trade theory.read more. This is high because strong currencies result in cheaper imports, and as a result, a nation opts to export less and import more.

#4 – Lower Inflation

With an appreciation in domestic currency, the imports will become cheaper, and the aggregate demandAggregate DemandAggregate Demand is the overall demand for all the goods and the services in a country and is expressed as the total amount of money which is exchanged for such goods and services. It is a relationship between all the things which are bought within the country with their prices.read more will also tend to fall. Therefore, all this together can lower the rate of inflationRate Of InflationThe rate of inflation formula helps understand how much the price of goods and services in an economy has increased in a year. It is calculated by dividing the difference between two Consumer Price Indexes(CPI) by previous CPI and multiplying it by 100.read more to a significant extent.

Causes of Currency Appreciation

  • Lower Inflation Rates- This means that a currency’s value with lower inflation rates will rise compared to the value of the currencies with a higher inflation rate. This is generally because a lower inflation rate causes higher interest rates. This will attract more international investmentInternational InvestmentInternational investments are made outside of domestic markets and offer portfolio diversification as well as risk management opportunities. As a result, an investor can diversify his portfolio and extend his return horizon by making international investments.read more in an economy, which, in turn, appreciates the demand for domestic currency.Investors’ Sentiment- Investors’ sentiment influences the demand and supply for domestic currency in an international market. This is why investors’ views are considered one of the important causes of appreciation or depreciation of the domestic currency.The other causes are government trade, recession, speculation, terms of tradeTerms Of TradeTerms of Trade (TOT) is defined as the ratio of a country’s import and export prices. The concept of terms of trade is important in economics as it explains the extent to which a nation can fund its imports based on the returns of its exports.read more, political stability, nation’s current accounts, etc.

Example of Currency Appreciation

An appreciation in the US dollar in comparison to Euro-

  • During the end of the year 2010 €1 = $1.20In the middle of the year 2011 €1 = $1.45This means in this period, there was a rise in the value of the Euro in comparison to the US Dollar.

However, in the year 2014, the value of the Euro fell against the value of the US Dollar.

Difference Between Currency Appreciation and Currency Depreciation

The key difference between currency appreciation and currency depreciation are-

  • Currency appreciation can be defined as a rise in the national currency’s value compared to international currencies. In contrast, currency depreciation can be defined as a fall in the national currency’s value compared to international currencies.It results in cheaper imports, whereas currency depreciation results in cheaper exports.It results in the rise of imports whereas currency depreciation results in exports.In a currency appreciation, the cost of financing foreign debts with respect to national currencyNational CurrencyA national currency (NC) is any form of money used by the people of a nation as a medium of exchange to engage in economic transactions.read more is reduced. In currency depreciationCurrency DepreciationCurrency depreciation is the fall in a country’s currency exchange value compared to other currencies in a floating rate system based on trade imports and exports. For example, an increase in demand for foreign products results in more imports, resulting in foreign currency investing, resulting in domestic currency depreciation.read more, the cost of funding foreign debts with respect to national currency is not decreased.It is more expensive, so it can be traded for a higher amount of international currency, whereas the same is not applicable in the case of currency depreciation.

Advantages

  • Currency appreciation can be advantageous as it helps in improving an individual’s standard of living. With an appreciation in the domestic currency, customers can take advantage of cheaper imports and increase their purchases. Domestic goods might become expensive, which will ultimately cause the imported goods to become cheaper on the foreign market.In such a phenomenon, buyers can purchase more international goods as the domestic currency can be easily used to purchase a higher value of global currencies.

Disadvantages

  • However, it can also be troublesome for an economy. If there is a rapid appreciation in the currency, it can become a major problem during economic disturbances. It can also be a reason for domestic countries to become less competitive in the international markets.It also leads to a rise in export costs. With the appreciation in an economy’s currency, the number of exported goods from that country will fall. This will harm the GDP as the same shall fall significantly.It may also cause trade deficits as strong currencies often lead to cheaper imports, and as a result, a country might want to import more than it exports.

Conclusion

  • Currency appreciation is the rise in the domestic currency’s value compared to a foreign currency. It enables imports to become cheaper and exports to become more expensive. The sentiments of the investors, lower inflation rates, political stability, nations’ current accounts, recession, government trade, terms of trade, speculation, etc., are the probable causes of currency appreciation.It leads to higher costs of exports, cheaper imports, lower inflation rates, etc. These impacts of current appreciation depend upon the ongoing situation of the economy and development in other nations.

This has been a guide to What is Currency Appreciation & its Definition. Here we discuss the impact of currency appreciation and its causes, along with the example and how it differs from currency depreciation. You can learn more about from the following articles –

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