The impact of changes in foreign exchange rates on aggregate demand and employment.

The activity is meant for a Principles of Macroeconomics courses
Students would have completed study of central macroeconomic variables (GDP, Unemployment, Price Level) and concepts (Aggregate Demand and Supply)

No class size limitations.

The activity (as well as follow-up discussions) can be completed within one 50 minute class period.

Overview

This activity is based on my observation that students often assume that one of the signs of a strong and growing economy is a "strong currency" (that is, a currency that is appreciating with respect to the currencies of major trading partners).

Students will be given a hypothetical situation that will require them to engage in logical reasoning of the impact of an appreciating currency on exports and imports, and consequently on Aggregate Demand, GDP and Unemployment. Based on team discussions students will realize that a strengthening currency may have differing impacts on different segments of the economy (consumers, producers, workers) and that in fact a "weak currency" can be beneficial during a recession.

Expected Student Learning Outcomes

Students will be able to evaluate the impact of changes in foreign exchange rates on a country's exports and imports.

Students will be able to evaluate the effect of changing exports and imports on Aggregate Demand, GDP and Unemployment.

Students will appreciate that changes in foreign exchange rates can have differing impacts on different segments (consumers, producers, workers) of the economy.

Information Given to Students

You are writing a letter to the editor in response to a politician's proposal to maintain a "strong US dollar" (against other currencies) as a way to recover from the current recession. Which of the following is the strongest argument you will make?

A) A "strong dollar" will help Americans buy more goods from other countries which is good for consumers during a recession

B) A "strong dollar" will discourage foreigners from buying American goods which is not good for American workers

C) A "strong dollar" will increase Aggregate Demand helping to bring us out of a recession

D) A "strong dollar" will decrease Aggregate Demand which will make the recession worse

E) The value of the dollar with respect to other currencies has no impact on the US economy

* This activity should be presented after students have been exposed to the concept of foreign exchange markets, as well as the effect of variation of exchange rates on net exports. Students should also have covered a basic analysis of Aggregate Demand and Supply.

* Students should be given 5 or 10 minutes to think about the question individually. And then they could be divided into groups of 3 or 4 students to discuss their ideas for another 15 -20 minutes.
Each group can then be asked to (simultaneously) present their best choice, after which the entire class can engage in deliberating and thinking about each possible answer.

* The instructor can guide the discussion and eventually help students see the possible merits of each answer. Finally, students may be given news articles (such as the one given below) to illustrate the practical implications of exchange rate fluctuations.

When discussing the merits of each possible answer, the following points could be made:

A) A "strong dollar" would obviously make foreign goods cheaper for Americans, but it will likely reduce net exports which could make the recession worse - some American workers will possibly lose jobs and for them cheaper foreign goods would not help.

B) This is obviously correct since a "strong dollar" will reduce net exports and can cause job losses in the U.S. - this is an argument against a "strong dollar" during a recession.

C) This argument is obviously incorrect since a "strong dollar" should reduce Aggregate Demand due to a negative impact on net exports.

D) This argument is obviously correct (as discussed above in "C").

E) This is obviously incorrect since the relative value of the US Dollar against other currencies has an impact on the level of U.S. exports and imports, which in turn impacts Aggregate Demand, GDP and employment.

A multiple choice question that could directly assess the intended learning outcome:

The exchange rate between the US Dollar and Japanese Yen moves from $ 1= 100 Yens to $ 1= 150 yens. Which of the following answers most likely represents the effect on the US economy?

A) US net exports will increase, unemployment will decrease, and GDP will increase

B) US net exports will decrease, unemployment will decrease, and GDP will decrease

C) US net exports will decrease, unemployment will increase, and GDP will decrease

D) US net exports will increase, unemployment will increase, and GDP will increase

The following news stories can be assigned after class to illustrate the above concepts and ideas:

"Weaker Dollar Seen as Unlikely to Cure Joblessness" - NY Times (November 15, 2010):

https://www.nytimes.com/2010/11/16/business/economy/16exports.html

"Japanese Official Blames Weak Dollar for slow world Growth" - NY Times (May 5, 1995):

https://www.nytimes.com/1995/05/05/business/worldbusiness/IHT-japanese-official-blames-weak-dollar-for-slow.html

"What's a Reverse Currency War and Who is Fighting One?" - Washington Post (June 2022):

https://www.washingtonpost.com/business/whats-a-reverse-currency-war-and-whos-fighting-one/2022/06/23/dbea46a2-f2ab-11ec-ac16-8fbf7194cd78_story.html