Evaluate the economic implications for the global economy of falling dolla ? (30)
The US dollar has fallen significantly in 2007. This follows several years of continuing dollar weakness. With no seeming end in sight for the falling dollar, it is a good question to ask the economic implications for other countries.
1. US exports become cheaper more expensive. Therefore there is an increase in demand for US exports. This helps boost US AD
2. US consumers find Imports more expensive. Therefore there will be a fall in demand for imported goods. This could lead to lower growth in other countries, especially those who rely on exports to US, such as China. Note: US is the world’s biggest importer. Therefore, if US consumers reduce their imports there will be a considerable impact on other countries. However, the impact may be less than it was due to the rise in Indian and Chinese consumer spending.
3. A falling dollar may cause inflation in the US. This is because AD is higher, imports more expensive and American firms may have less incentives to cut costs. However, since the US is potentially heading into recession. The rise in AD may be a good thing for the US economy and therefore the rest of the world. An American recession would cause a slowdown in global growth a devaluation may stop this.
4. Reduce the US current account deficit. It should also reduce the Chinese current account surplus. This some may help reduce some of the economic imbalances in the global economy.
5. Countries which export a lot to the US may witness a fall in economic growth. The Chinese government is worrying about this situation. It is one reason why they are trying to prevent the Yuan appreciating too much.
Evaluation of a Falling Dollar
- The impact of a devaluation depends upon the elasticity of demand for exports and imports. If demand is relatively inelastic then an increase in the price of imports may not reduce the value very much. If this is the case, the impact of a devaluing dollar will be limited.
- There are many other factors which influence economic growth. A devaluation may boost AD in US and reduce growth in other countries. E.g. If the US housing market continued to decline then consumer spending would fall and therefore US AD would not increase, the US could still experience a recession.
- The Chinese economy is growing so fast an appreciation may be beneficial because it helps to reduce inflationary pressures in China.
- Sometimes a devaluation has a lagged effect. This means it takes time before a devaluation effects global growth.