Taming the Currency Hype

IMF Blog, August 21, 2019

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Taming the Currency Hype

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Bibliographic details

• Authors: Gustavo Adler, Luis Cubeddu, Gita Gopinath
• Published: August 21, 2019

Context and summary

• Authors: Gustavo Adler, Luis Cubeddu, Gita Gopinath
• Date: August 21, 2019
• Main point: Escalating trade tensions and policy responses have weighed on global growth forecasts for 2019-20; exchange rate movements and monetary easing cannot be relied on to correct large trade imbalances, and tariff- or currency-targeting measures are likely counterproductive. Durable solutions require macroeconomic and structural policies by both deficit and surplus countries and cooperation to address trade disputes.

Exchange rates can’t do it all

• Monetary easing stimulates domestic demand and can boost demand for other countries’ goods, but also weakens the exchange rate, producing expenditure switching.
• Key empirical findings (from the 2019 External Sector Report):
  • Expenditure switching effects are generally small, especially within a 12-month period.
  • A 10 percent depreciation (vis-à-vis all currencies) improves a country’s trade balance by about 0.3 percent of GDP in the near term, on average, with most effects coming through a contraction of imports.
  • Over a span of three years, a 10 percent depreciation leads, on average, to a 1.2 percent of GDP improvement in the trade balance.
• Reasons for muted effects:
  • Trade is largely invoiced in dollars, so export volumes tend to respond little to exchange rates in the short run.
  • For the United States, the muted impact reflects a weak response of imports.
• Conclusion: Exchange rates facilitate durable external adjustment but the expenditure switching effect of currency weakening and its negative impact on trading partners should not be overplayed.

Counterproductive policy options

• Tariffs:
  • Tariffs and exchange rates work differently; a 10 percent tariff does not necessarily offset a 10 percent more appreciated exchange rate.
  • Example: Since early 2018, the average US tariff on goods imported from China increased by about 10 percentage points and would increase by another 5 percentage points if recently announced plans are carried out.
  • Meanwhile, the renminbi has depreciated by about 10 percent relative to the dollar, largely as a result of these trade actions and associated uncertainties.
  • In practice, US importers and consumers are bearing the burden of tariffs because dollar invoicing has minimized the impact of the stronger dollar on the dollar prices Chinese exporters receive.
  • Higher bilateral tariffs are unlikely to reduce aggregate trade imbalances because they mainly divert trade to other countries.
  • Negative consequences: harm to domestic and global growth by sapping business confidence and investment, disrupting global supply chains, and raising costs for producers and consumers.
• Direct attempts to weaken the currency:
  • Proposals to buy foreign currencies or tax inflows to offset other countries’ policies are cumbersome and likely ineffective given the depth of reserve currency markets (dollar, euro).
  • Such measures have negative implications for the orderly working of the international monetary system.
• Risks of retaliation:
  • Policies of either kind will likely encourage retaliation, undoing any benefit for a single country and making all nations worse off.
  • Such actions may also possibly violate international obligations such as those to the World Trade Organization.

Constructive, shared solutions

• Broad assessment:
  • External positions are not grossly misaligned; external imbalances are down sharply from the peaks seen during the global financial crisis.
  • The dollar was only moderately overvalued in 2018, contrasting with the mid-1980s situation that prompted the Plaza Accord.
• Policy recommendations:
  • Both deficit and surplus countries should tackle underlying macroeconomic and structural sources of imbalances rather than adopt ineffective or counterproductive measures such as tariffs.
  • For deficit countries (examples: the United States and the United Kingdom):
  • Reduce budget deficits without sacrificing growth.
  • Strengthen competitiveness of export industries, including investing more in skills of workers and encouraging old-age saving.
  • For surplus countries (examples: Germany and Korea):
  • Use fiscal policy where possible to invest more in infrastructure.
  • Adopt reforms that encourage private investment, such as supporting innovation through tax incentives for research and development and lowering barriers to entry in business services and regulated professions.
  • For China (external position broadly in line with fundamentals in 2018):
  • Further structural reforms to ensure lasting external rebalancing and to address vulnerabilities from high levels of private and public debt (see the 2019 Article IV consultation for China).
  • Steps include reforming state-owned enterprises, enhancing the social safety net, opening up more sectors to private and foreign competition, and removing impediments to trade.
• Multilateral responsibilities:
  • Surplus and deficit countries share responsibility for a stronger, more balanced global economy.
  • Durable solutions should include addressing concerns about export subsidies and weak intellectual property protection and modernizing the international trade system in areas such as services and e-commerce.
  • Currencies are neither the hammer nor the nail when confronting problems like rising inequality and sluggish growth.

References

• Português
• forecasts
• 2019 External Sector Report
• https://www.imf.org/wp-content/uploads/2019/08/eng-aug-19-currency4.png
• https://www.imf.org/wp-content/uploads/2019/08/Chart-1-Currency-Blog.jpg
• earlier blog
• https://www.imf.org/wp-content/uploads/2019/08/eng-august-15-currency2-2.png
• https://www.imf.org/wp-content/uploads/2019/08/eng-august-15-currency3-2.png
• 2019 Article IV consultation for China