Effects of a Falling Dollar

An essay on the economic effects of a falling dollar.

Trade weighted dollar index

Between 2006 and early 2008, there was a 15% fall in the trade-weighted value of the dollar.

Then from 2008 to 2011, there was another fall of around 15%.

In summary, a fall in the value of the dollar

  • Makes US exports cheaper to foreigners importing US Goods.
  • It is cheaper for non-US citizens to go on holiday to the US.
  • US consumers face higher price of imported goods.

1. A boost in US manufacturing sector

A lower dollar increases the price competitiveness of US exports. Cheaper exports will lead to an increase in demand. If demand is price elastic then there will be an increase in the value of exports.

  • However a devaluation is often just a temporary increase in competitiveness. 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 /imported goods, so the growth in demand for imports will slow. It may encourage US consumers to switch to domestically produced goods.

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. In the long-term, firms cannot keep absorbing the price increases.

3. Improvement in US current account.

Assuming the Marshall Lerner condition is satisfied i.e. PEDx +PEDm > one then a devaluation will improve the current account and reduce the current account deficit.

4. Temporary improvement in US Economic growth and employment

increase-AD-Keyneisan-LRAS-middle

With rising export demand this will help increase output and therefore there will be a reduction in unemployment. Also, with imports more expensive, this will increase demand for domestically produced goods. However, if the devaluation causes a rise in inflation, then it may lead to higher interest rates which hold back economic growth.

5. Lower growth and lower inflation in US trading partners

If the US dollar falls in value, the Euro and Yen will appreciate. This will have the effect of causing

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.

Some Latin American and Asian countries such as Thailand have a semi-fixed exchange rate against the dollar. Thus if there is a fall in the dollar, they will also see a fall in the value of their currency – helping their exports.

Evaluation

It also depends on why the dollar is falling.

  • If the dollar is falling due to higher inflation – then the US may not be benefitting from improved competitiveness.
  • If the dollar is falling due to a cut in US interest rates – then this maybe a double cause of rising aggregate demand. Lower interest rates boost consumer spending and lower exchange rates boost export demand.

It depends what else is happening in the economy.

If the dollar falls in value but consumer confidence is weak then we will not get much boost in aggregate demand.

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By on November 28th, 2016 in