Why gains from devaluation are just a delusion..

Prof Steve Hanke has an article on this delusion:

The advertised goal of a devaluation is to increase the price of foreign produced goods and services and decrease the price of domestically produced goods and services. These changes in relative prices are supposed to switch domestic and foreign expenditures away from foreign produced goods and services towards those produced domestically. This is supposed to improve the devaluing country’s international trade balance and balance of payments.

For the public, this argument has a certain intuitive appeal. After all, a devaluation is seen as nothing more than a price reduction for domestically produced exports, and price reductions are always seen as a means to increase the quantity of goods sold. When it comes to currency devaluation, the analysis is not that simple, however. Even if we use a narrow, Marshallian partial equilibrium model (one consistent with the common man’s economic intuition) to determine the effects of a devaluation, the analysis becomes quite complicated. Contrary to the common man’s conclusion, a devaluation will often result in a reduction of exports and a deterioration in a country’s trade balance and balance of payments. When the models become more general and inclusive, a light shines even more brightly on just how confusing and contradictory the arguments favoring devaluations are. Calls for devaluations, as popular as they might be, are a delusion.

But, without entering the technical weeds of economic analysis, it is clear why a devaluation strategy is a loser’s game. In 1947, the famous Cambridge don Joan Robinson penned “Beggar-My-Neighbor Remedies for Unemployment.” She not only coined the phrase “beggar-my-neighbor,” but concluded that so-called competitive devaluations would be unsuccessful in achieving their advertised objectives. Among other things, Robinson wrote that a devaluation would prompt a retaliation in the form of a competitive devaluation. Thus, the initiator of a currency war could, and would, always be neutralized — checkmate.

Most things in economics are just that – a delusion..


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