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The Interest Rate Transmission Mechanism

The Balance of Payments: Deficit

We have already seen how a rise in the interest rate impacts on the exchange rate. Other things being equal, we would expect the exchange rate to appreciate. This would lead to the effective price of exports rising (Px↑) as foreigners now have to give up more $ to get the same amount of £s and the price of imports to appear to fall (Pm↓). (The UK buyer gets more $ for every £.)

Basic supply and demand theory would suggest that if the price of exports rises then demand would fall whilst the fall in the price of imports would lead to a rise in demand. The next animation shows what the end result would be.

You can start and stop/reset the animation using the buttons provided or by tabbing to the animation and pressing s to start and q to stop. The main introductory page features further accessibility information on these resources.

The animation would displays two sets of counter values in pounds - one for export earnings, the other for import expenditure for the UK. Goods are represented by different coloured boxes, which flow between the UK and US representing imports and exports. As the goods flow, the counter values begin to rise. The end of the animation shows the level of export earnings at £50 and the level of import expenditure also at £90 to illustrate a deficit on the balance of payments for the UK.

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