Falling Dollar and Recession in the EU

A look at the impact of a falling dollar / Euro on the EU economy.

I was reading some of your essays about the impact of the devaluation of the dollar. At first glance, this could cause a recession in the European economy (lower inflation, lower growth). But analyzing (with the little economic knowledge i have :-P) i came up with the conclusion that:
– Depending on the spare capacity the economy has, the falling of the dollar can have a positive long term growth. My argument is that companies will be able to produce more (buying raw materials at a lower price assuming they are priced in dollar-) without having to pass the cost onto the consumers… Is this possible or am i wrong?
Appreciate your help

In recent months, the dollar has been devaluing and the Euro has been appreciating significantly.

If the Euro appreciates – what impact will this have on the European growth rate? Is it possible a very strong Euro could cause a recession in the Eurozone?

  • If the Euro appreciates (increases in value) it makes the price of EU exports less competitive. Americans have to pay more dollars to get the same EU goods. Therefore, this is likely to cause a fall in demand for EU exports.
  • Trade accounts for a large % of the Eurozone economy, therefore, a fall in exports will have a negative impact on the rate of economic growth. If the Euro increases too much it could cause serious problems for exporters and possibly a recession.

However, the impact on the EU depends on a few different factors.

  • It is cheaper for EU firms to import raw materials because the Euro is stronger. Therefore, if firms import a lot of raw materials they will have lower costs. However, the benefit of cheaper raw materials is lower than the cost of more expensive exports (imported raw materials are only a small % of the final export price)
  • How does the ECB respond? A strong currency and reduction in inflationary pressures means that the ECB has more room to cut interest rates. High exchange rates reduce inflation and so enable lower interest rates. Lower interest rates enable increased economic growth
  • Elasticity of demand for EU exports. If demand is inelastic, higher prices will not reduce demand very much.
  • Other factors influencing economic growth such as consumer confidence, house prices e.t.c.

Conclusion

A strong Euro does pose economic difficulties, especially for exporters. It could cause a slow down in growth and possibly recession. However, it depends how the ECB respond and also how much the EURO continues to rise.