Thursday, May 01, 2008

Sexy Currency Depreciation

Wille Faler has tipped me of this article by Roger Bootle, managing director of Capital Economics, which argues that the key for saving Britain from its current problems are a weaker pound, something which of course have already happened. While he cautions that a weaker pound may not improve British people's sex life, he seems so generally enthusiastic about it that one might be forgiven for getting the impression that it turns him on.

But setting aside the issue of Bootle's possible weird sexual leanings, is it true that a weak currency is the key to economic success. In short, no. A weak currency will no doubt boost net exports, but it will also depress domestic demand by reducing domestic purchasing power. So, ultimately all it will do is shift economic activity from domestic to foreign demand.

Because it enables looser monetary policy (indeed, in the case of freely floating currencies it is in most cases caused by that in the first place). It is no coincidence that the pound, along with the U.S. and Canadian dollars, has been the weakest currencies in recent months-, and because import prices are somewhat sticky in the short-term, a weaker currency might create a short-term upswing. But in the long-term, the reduction in domestic purchasing power will cancel out the higher net exports.

What about Bootle's empirical claim that currency devaluation was what enabled Britain to recover after 1992? That hardly proves anything, as there were other factors, most notably the upswing for London's financial sector which enabled it to boom in the 1990s. There are several examples of countries with weak currencies that did not experience any sustainable upswing, for example Italy that devalued at the same time. Other examples include Mexico and Japan in recent years.


Post a Comment

<< Home