The exchange rate is the price of one currency in terms of another. A fall in the value of the pound is known as a depreciation and affects both the level of aggregate demand and the costs of production for firms in the UK economy. //One way in which a fall in the exchange rate can be beneficial for the UK economy is that it “should help UK exporters whose goods will be cheaper overseas”. An UK exports are priced in Sterling, and when Sterling can be purchased more cheaply, this makes our goods more affordable. An increased demand for UK exports is an injection into the UK economy and would serve to boost aggregate demand, enabling UK firms to make use of any spare capacity in order to increase output. This would also lead to a higher derived demand for resources, including labour, thus reducing unemployment. //A second effect of the depreciation on aggregate demand occurs because UK imports would become more expensive due to the fall in the purchasing power of Sterling. This should lead to reduced demand for imports and a reduction in the leakages from the UK circular flow of income. Overall, then, a fall in the exchange rate should boost exports and reduce imports and hence support aggregate demand and economic growth, as shown in the diagram. ///D A fall in the exchange rate could support economic growth by boosting AD I A negative effect of a fall in the exchange rate is that it may “add to inflationary pressures”. This is for two reasons. Firstly, the increase in aggregate demand may give rise to demand-pull inflation if there is only a small output gap and hence limited spare capacity. If too much money is chasing too few goods firms are in a stronger position to put up prices. This can be seen as the rationing function of prices in individual markets aggregated across the economy. Further, cost-push inflation may occur as imported raw materials and