Thursday, June 7, 2007

The effects of a devaluation in the Dollar

Assess the likely implications of a devaluation in the dollar. (12)

Should we concerned about a rapid devaluation in the dollar?

Benefits of devaluation

Economic Growth

If the dollar becomes weaker, exports become cheaper leading to an increase in demand for US exports. This can help to increase AD and improve the rate of economic growth. This may be important, because problems in the US housing market are threatening the rate of economic growth. Falling house prices are potentially reducing consumer spending, therefore, a rise in exports could help to boost economic growth and prevent any move towards a recession.

Balance of Payments.

The US has a large current account deficit (7% of GDP) therefore a devaluation will help to improve and reduce the current account deficit. However, a devaluation alone is unlikely to solve the problem. Also, there is evidence that demand for exports and imports is relatively inelastic; therefore, any devaluation will have a small impact on the value of exports and imports. It is argued that the fundamental reason for a deficit is the low levels of domestic savings and consequently high levels of consumer spending.

Inflation

A devaluation may lead to increased inflationary pressures for 3 reasons:

1) Increase in exports causes rising AD and therefore could lead to demand pull inflation.
2) Imported goods will be more expensive. American consumers would definitely experience a rise in price for many imported manufactured goods and imports of raw materials could increase costs of business.
3) It is argued a devaluation reduces the incentive, for manufacturers and exporters, to cut costs and become more efficient.

However, the impact of a devaluation depends on the state of the economy. As previously mentioned, the US economy is slowing down; therefore inflationary pressures are subdued and therefore inflation is unlikely to occur.

6 comments:

Kurt N said...

Since this website has the intention of helping others learn, it would be prudent to define your acronyms. For example, you used the acronym 'AD'. Due to the context of the paragraph, I'm guessing you mean "Aggregate Demand".

If you're unable to use acronym tags with the "title" option in the body of your text, then perhaps leaving out (or explaining) them would be beneficial.

Additionally, there are some grammatical errors in your text (e.g. "Should we concerned about a raipd devaluation in the dollar?").

Nit picking aside, thank you for explaining these important concepts.

Doko said...

I really enjoy reading your posts. I've got a question, how would the dollar be devalued? Thanks a lot

Doko said...

I mean, in what ways do they actually make the dollar depreciate against other currencies?

Sam said...

I am not an expert in Economics but simply a professional and small business owner, largely believe in on commonsense. To be honest, after B-School, have not touched this great science.
While we think on the dollar devaluation hypothesis and analyze that devaluation of dollar would make imports significantly expensive to the US. However, what we undermine the fact that if the dollar is devalued then many of the manufacturing and services would be back in US and that would trigger the higher levels of steady employments and overall prosperity.
We need jobs, long-term jobs and without this any number of stimulus package is not sufficient. I belong to the business family and what we have been taught is if someone does not have money then charity is not going help all the time to the receiver – what would help is work, work that can help to remain economically viable. This is exactly our issue is (of the common men, women and not those Madoffs!).
If we do not improve our economic condition than in any case our investments (in USD) are going to go down. So why not to correct ourselves and be more people centric.
The idea expressed here is only as an academic interest and nothing to do with my political and geographical belief. No matter how bad the situation would be, my belief in America would never change.

Anonymous said...

to devalue a currency is to increase the money supply to the country. which means printing more money. so the more money the government distributes through printing instead of earning from the market, the lower the value.

Anonymous said...

From the Economic Growth section above.

"If the dollar becomes weaker, exports become cheaper leading to an increase in demand for US exports."

What is described as a "weaker" dollar is one that would be stronger in terms of trading currency and stronger in terms of its ability to help improve the sale of exports. The word weaker should be more correctly listed as Less Inflated and Stronger..
Weaker is a description that would apply to what a stronger dollar will do to falsely inflated equity. It will weaken the stock market. Therefore the stockmarket weakening is a sign that things are right sizing and the dollar is strengthening. And the value of a true asset gold would also then likely drop as the stronger dollar is worth more.