Why Exchange Rate Changes Will Not Correct Global Trade Imbalances

Ronald I. McKinnon

in The Unloved Dollar Standard

Published in print December 2012 | ISBN: 9780199937004
Published online January 2013 | e-ISBN: 9780199980703 | DOI:
Why Exchange Rate Changes Will Not Correct Global Trade Imbalances

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The commonly used elasticities model of the balance of trade projects that a country's trade surplus will decline if its currency is appreciated. Its exports become more expensive to foreigners, and imports look more expensive to domestic nationals. So with moderately high price elasticities, a creditor country's trade surplus should fall. However, in a macroeconomic sense, this model is (too) insular because it ignores the direct effects on domestic spending (absorption) of exchange rate changes. If instead one posits a more open economy where the investment decision is globalized, then a discrete appreciation would increase the cost of investing and producing in that country, and investment would slump. For a creditor country, the value of its domestic claims on foreigners would also fall, further reducing domestic absorption. Thus imports could fall even as exports weaken. So the effect on the net trade balance is ambiguous. “China bashing” to appreciate the renminbi to reduce China's trade surplus is unwarranted.

Keywords: trade imbalance; elasticities model; absorption approach; globalized investment; China bashing

Chapter.  1355 words. 

Subjects: Financial Markets

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