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Effects of a Falling Dollar
essay on economic effects of a falling dollar
1. Boost in US manufacturing sector.
A lower dollar increases the price competitiveness of US exports, last year exports increased by 18%.
· The increase in value of exports suggests the demand is elastic, lower prices lead to a bigger % increase.
- However a devaluation is often just a temporary increase in competitivenes. Devaluation often causes inflationary pressures which reduce the temporary gain in competitiveness
2. Increase in US import prices.
US consumers will face increased prices of European goods so the growth in demand for imports will slow.
· However to some extent EU manufacturers can prevent price increases by reducing profit margins and cutting costs and becoming more efficient, however there is a limit to this. With a 33% increase in the Euro this is becoming more difficult.
3. Improvement in US current account.
Assuming the Marshall Lerner condition is satisfied i.e PEDx +PEDm >1 then a devaluation will improve the current account and reduce the deficit. However to eliminate a deficit of 6% of GDP will require a massive devaluation
4. Temporary improvement in US Economic growth and employment
· With rising export demand this will help increase output and therefore there will be a reduction in unemployment which is politically
· Inflation in the US is still very low (although now starting to creep up)this is why the federal bank are not concerned about a falling $ and rising AD.
5. Lower Growth and lower inflation in the EU.
The Euro has borne the brunt of the rising dollar and this will lead to the opposite effect of falling Exports to the US .
Inflation will be lower in the EU, this is because
1. Imported goods will be cheaper (Many raw commodities are priced in dollars)
2. AD will be lower or increase at a slower rate.
3. Manufacturers have increased incentives to cut costs. therefore a devaluation will help reduce EU inflation.· This could cause a recession but evidence suggest EU growth is more resilient and the ECB have said a cut in interest rates is not necessary at the moment.
6. Pressure to revalue Chinese Yuan and Other currencies.
· China and other Asian countries such as Thailand have a fixed exchange rate against the dollar. Thus at the moment they are benefiting from a competitive exchange rate increasing exports and creating more jobs.
· However arguably the Chinese economy would benefit from a moderate appreciation. This is because growth is very fast and it is approaching full capacity and therefore could cause an increase in inflationary pressures. AN increase in the value of the currency would help reduce this
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