Inflation, Deflation, World Trade, and Exchange Rates

Inflation and Deflation

Inflation is an increase in prices, reducing purchasing power. It occurs when the price of goods and services rises faster than salaries. Consequently, demand falls, leading to reduced production and a decrease in GDP.

Deflation is when prices fall more than wages. This leads to increased demand, increased production, and a rise in GDP.

World Trade Dynamics

World Trade Without Restrictions

• Higher prices
• Fewer consumer choices

World Trade With Restrictions

• Protection of national defense and citizen health
• Protection against dumping. Dumping occurs when manufacturers export a product to another country at a price either below the price charged in its home market or below its cost of production.
• Potentially lower prices for consumers (depending on the specific restrictions and market conditions)

GATT and WTO

GATT (General Agreement on Tariffs and Trade) was a multilateral agreement regulating international trade. Its purpose was the "substantial reduction of tariffs and other trade barriers and the elimination of preferences."

WTO (World Trade Organization) is an intergovernmental organization that regulates international trade. The WTO deals with the regulation of trade between participating countries by providing a framework for negotiating trade agreements and a dispute resolution process aimed at enforcing participants' adherence to WTO agreements. These agreements are signed by representatives of member governments and ratified by their parliaments.

Exchange Rates

Exchange rates represent the price of one currency in terms of another. Types of exchange rates include:

• Flexible
• Fixed
• In-between (e.g., bands, European Monetary System)

An increase in the exchange rate of Euro/Foreign Currency would appreciate our currency. This would make our imports cheaper but our exports more expensive, potentially destabilizing the current account.

Conversely, if our currency depreciates, we can sell more cheaply, thus increasing our exports. However, we would buy more expensively, so our imports would decrease. The actual impact depends not only on price but also on elasticity. For instance, if we are energy-dependent (as many countries are), we would likely buy a similar amount of oil and gas, but at a higher price. Similarly, if our exports have low elasticity, even with a price reduction, our goods might not experience a significant increase in demand.

Currency Depreciation

If the pound devalues (depreciates):

• Exports become more competitive, increasing demand for exports.
• Imports become more expensive, leading to lower demand for imports.
• Depreciation will tend to increase economic growth but also cause inflation.