Sunday, March 9, 2008

Exchange Rates and the Economy

One of the basic aspects we teach students about exchange rates is that a stronger currency brings benefits the consumer through cheaper imports; and a weaker currency brings benefits to the producer through cheaper exports. Something that doesn't get covered as often is that a floating exchange rate can be a natural correction mechanism for trade flows. When one country's (country A) currency is stronger than another country's (country B) currency for a period of time, that can help create a trade deficit -- imports into country A are greater than its exports to country B. At some point, the country B may be willing to exchange more of country A's currency for its own currency, thus "weakening" the currency from country A and "strengthening" the currency from country B - units of B are worth more units of A in trade than previously. But that's not always a bad thing.

This opinion piece by former Federal Reserve Bank of Dallas President, Bob McTeer was in Saturday's edition of The Wall Street Journal and provides a good explanation of how the strength of a
country's currency is not always indicative of the underlying economic strength. And a weaker currency can, at times, be beneficial in a nation's efforts to hold off recession. You might want to read it over and see how you can integrate it into your classroom discussion. It makes some sound points. And I think his paraphrasing of St. Augustine may be appropriate: "Lord, make our dollar strong, but not just yet."

I look forward to your comments.

1 comment:

Mike Fladlien said...

some students see the dollar depreciating and see the trade deficit increasing...will you make a post on this?