Is currency devaluation overrated?


A RIP-ROARING GLOBAL DEBATE is underway over whether currency devaluations are overrated as a means of enhancing national prosperity. An International Monetary Fund study suggests that between 1980 and 2014, a 10 percent depreciation by a country against the currency of a trading partner increased net exports by 1.5 percent of GDP. The bulk of the increase came in the first year after depreciation.

The conclusion now, however, is that devaluations are not having the same impact on GDP performance. The factors mentioned for this surprising new impotence are: 1) the collapse of global commodity prices; 2) the frequent scenario where economies with high commodity prices experience capital inflows that push up exchange rates while depressing exports, but when the currency weakens, that weakened export sector is unable to take advantage of the more competitive exchange rate; and 3) the off-setting effect of global supply chains with products being manufactured from a multitude of worldwide sources.

If the effectiveness of devaluation is coming into question, how will governments respond? Will officials whose economies are in trouble resort to efforts to try to control the flow of capital? Will a scenario emerge where countries faced with the declining effectiveness of currency depreciation conclude that the answer is actually more aggressive depreciation? In other words, if the medicine's not working, increase the dosage? What is the likely outcome of this debate?

Nearly thirty experts debate the issue.

The impact of a devaluation depends importantly on the pricing policy of the exporting companies.


Professor of Economics, Harvard University, former Chairman, President Reagan's Council of Economic Advisors, and former President, National Bureau for Economic Research

Although a currency devaluation will raise GDP in a country with less than full employment, the extent of the increase will differ substantially from country to country depending on the composition of its exports and imports and the mix of the countries with which it trades. Some exports trade in competitive markets and have a high price elasticity of demand. Other exports such as specialized machinery tend to have a much lower price elasticity and are therefore less responsive to currency change.

The impact of a devaluation depends importantly on the pricing policy of the exporting companies. In an important paper presented at the 2015 Jackson Hole Federal Reserve conference, my Harvard colleague Gita Gopinath showed that many companies invoice their exports in dollars and change their dollar prices only very slowly when the exchange rate changes. As a result, a currency devaluation does little to increase the volume of their exports but does increase their profits. We have seen this very clearly in Japan in recent years.

Even when devaluation has little effect on GDP, central banks will continue to use monetary policy to devalue their currencies for a different reason. With existing inflation rates far below their target values, the European Central Bank and the Bank of Japan can use currency devaluation to increase domestic inflation by increasing the prices of imports.

In almost all cases, devaluations work.


Non-Resident Senior Fellow, Peterson Institute for International Economics, former Assistant Secretary for International Affairs, U.S. Treasury, and former Director of the Division of International Finance, Federal Reserve Board

In every significant devaluation of the past fifty years or so, skeptics have argued initially that devaluation is not working to improve the current account or net exports and therefore real GDP. In almost all cases, the skeptics were wrong. They said that the country does not meet the Marshall-Lemer conditions on import and export price elasticities for a devaluation to be effective, but if that were the case, the country should appreciate its exchange rate to improve its current account and boost GDP, and I know of no cases where that has worked. They said that devaluations do not work because the real effects get eaten up by rising inflation, and that is true if the central bank continues to print money to fuel inflation when the economy is near full employment. Expenditure switching often must be supported by other macroeconomic policies. They said that devaluation damages balance sheets and although it may boost net exports, it depresses domestic consumption and investment and the net effect on GDP is negative, but in those cases as in the Asian crisis, the recovery of GDP may be slow in coming but it does come and is led by net exports. Now they say that because of supply chains or some other feature of the globalized economy, devaluation does not work, but these skeptics forget that devaluation works on the import side as well as the export side. Sure, devaluation may not increase the demand for commodity exports which are price inelastic, but it can reduce the demand for imports and shift that demand to the domestic economy.

The effects of a devaluation on the current account, net exports, and GDP are not uniform across countries in terms of magnitude and timing, but it would be foolish to throw out 150 years of economic history because once again some people are saying "devaluation does not work." The likely outcome of this debate will be to conclude once again that devaluations in almost all cases do work, but then we will have the same debate again in ten or twenty years.

Japan has long illustrated the drawbacks of prolonged currency depreciation.


President, Nakamae International Economic Research

Japan has long illustrated the drawbacks of prolonged ultra-easy monetary policies and currency depreciation. Two years ago (TIE, Fall 2014), I warned that a weaker yen would exacerbate Japan's trade deficit (nominal exports would increase but real exports would decline because Japanese companies have moved their factories abroad; simultaneously, a weaker yen would increase the value of imports). All this has served to weaken a fragile economy. Consumers have lost purchasing power as food and energy prices have gone up. And wages remain stalled as producers remain pessimistic about the global economy.

So Japan is once again in the midst of consumer-led recession. Yet in terms of economic policy--notably monetary policy--little has changed since Shinzo Abe, the prime minister, took office in 2012. Even as other developed countries followed Japan's charge into zero (or lower) interest rate territory, the global economy has suffered more setbacks.

Last month, Japan demonstrated its willingness to double down on its experiment. Other regions may yet follow its lead. Why are policymakers bent on pursuing a strategy that is controversial at best, and a failure at worst? Aggressive monetary easing--and the resulting fall in currency--was once used in hopes that it would lift exports and production, improving the economic outlook which would then boost stock markets. These days, however, the tail seems to be wagging the dog. Officials seem to hope that bolstering stock prices will somehow improve economic performance.

This has not been the case. The effects of these booster shots have been temporary--quickly overwhelmed by, say, contraction and deflation in China, or falling commodity prices (or both) as bubbles created by ultra-easy monetary policies continue to burst. And the benefits of rising stock markets have become increasingly limited as the polarization of wealth has become more extreme. In Japan, a stock market-centric strategy is even less effective since fewer than one-sixth of households own any equities.

Nor would any of this be possible without encouragement from big investors--banks, brokers, and hedge funds, primarily in New York and London. Currency devaluation, whether in the form of quantitative easing or negative interest rates, greatly appeals to those whose performance is judged by short-term benchmarks rather than long-term goals. Perhaps we need to start debating why policymakers, especially central banks, are so heavily influenced by stock markets and their movers. Alternatively, perhaps someone will find incentives for investors to start rewarding long-term economic performance. Unless, of course, a long-overdue and substantial correction does that for them.

Depreciations f have to be bigger to achieve the effect desired.


CEO, Connolly Insight, LP

One has to take account of what would have happened without currency depreciation: in the much-cited case of Japan, for instance, the correct comparison is not between net exports now and net exports when the yen depreciated; it is between net exports now and what net exports would have been if the yen had not depreciated.

That said, the factors invoked in recent discussion-- global value chains; falling commodity prices; and export sectors weakened by previous over-appreciation--can indeed help explain an apparently decreased sensitivity of net exports to currency depreciation. Global value chains, in particular, mean that output in the traded sector overestimates the degree of openness of the economy, value added being much less than output. This means that depreciations have to be bigger to achieve the effect desired by policymakers.

In most periods of capitalist economic history, this would not have been a problem. International imbalances, not global intertemporal imbalances, were typically the problem. But it now begs the question of what it is that policymakers desire. Abenomics, for instance, received general praise because it was seen as involving, via lower Japanese yields, a move along a given currency forward-curve for the yen. That had a substantial impact in reducing global yields, notably in the euro-area periphery, and supporting global stock markets. This was judged to provide net support to output in the rest of the world (ex Japan) even though Japan's...

To continue reading