Bring On the Currency War
The U.S. government seems concerned about what will happen if other big nations push down the value of their currencies against the dollar. Actually, it could be good for the global economy.
Ahead of this week's meeting of finance ministers from the Group of Seven developed nations, Treasury Secretary Jacob Lew has warned that the U.S.'s counterparts -- the three largest euro-area nations plus Canada, Japan and the U.K. -- might undermine global growth if they engage in policies that cause their currencies to depreciate against the dollar. In my view, his concerns are misplaced.
In one way or another, all the G7 countries are suffering from a dearth of inflation, which is running well below their central banks' targets. All would be more likely to achieve their inflation objectives in a timely fashion if their currencies were to depreciate persistently against the dollar.
A stronger U.S. dollar would help other G7 nations with respect to inflation in two ways. The first effect is mechanical and relatively short-lived: When, for example, the dollar value of Japan's currency declines, imports from the U.S. become more expensive in yen terms, giving an immediate boost to inflation. The second is more persistent: Japanese exports to the U.S. become more profitable in yen terms, causing exporters to bid up the wages of Japanese workers, a dynamic that generates more inflation within Japan.
But wouldn’t a stronger dollar harm the U.S.? I see two reasons why it wouldn’t, as long as the appreciation isn’t too large.
For one, the U.S. is in a different monetary policy position, with the Fed on track to raise interest rates. By slowing (or even reversing) planned interest rate increases, it can undo much of the adverse effects of a moderate dollar appreciation on inflation and employment. (In this regard, Canada is in a similar position.)
The second reason, as documented by Gita Gopinath of Harvard University, is that globally traded goods are priced largely in dollars, and those prices don’t change much in response to exchange rate fluctuations. Hence, when the dollar appreciates against the yen, Americans pay only slightly lower dollar prices for Japanese imports, while the Japanese pay much higher yen prices for American imports -- and a given dollar appreciation increases the Japanese inflation rate by a lot more than it decreases the U.S. inflation rate.
Bottom line: Currency depreciations would help many of the U.S.'s G7 partners a lot while hurting the U.S. little, if at all. In other words, a G7 currency war would be fine as long as the U.S. remained a pacifist.
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