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The Unloved Dollar StandardFrom Bretton Woods to the Rise of China$
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Ronald I. McKinnon

Print publication date: 2012

Print ISBN-13: 9780199937004

Published to Oxford Scholarship Online: January 2013

DOI: 10.1093/acprof:oso/9780199937004.001.0001

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Why Exchange Rate Changes Will Not Correct Global Trade Imbalances

Why Exchange Rate Changes Will Not Correct Global Trade Imbalances

Chapter:
(p.130) Chapter 8 Why Exchange Rate Changes Will Not Correct Global Trade Imbalances
Source:
The Unloved Dollar Standard
Author(s):

Ronald I. McKinnon

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780199937004.003.0008

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

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