EECS 1530 Lecture Notes - Lecture 7: International Trade, Floating Exchange Rate
21 Jun 2018
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EECS 1530 Lecture 7 Notes
Introduction
Why Exchange Rates May Not Correct a Balance-of-Trade Deficit
Once the country’s home currency’s value declines in response to these forces, the
result should be more foreign demand for its products.
A floating exchange rate will not correct any international trade imbalances when there
are other forces that offset the effects of international trade flows on the exchange rate.
EXAMPLE
Since the United States normally experiences a large balance-of-trade deficit
International trade flows should place downward pressure on the dollar’s value.
Yet in many periods there are more financial flows into the United States (e.g., to
purchase securities) than there are financial outflows.
These forces offset the downward pressure on the dollar’s value caused by the trade
imbalance.
If the value of the dollar does not weaken in such circumstances, a floating exchange
rate will not correct the U.S. balance-of-trade deficit.
Limitations of a Weak–Home Currency Solution
Even if a country’s home currency weakens, there are several reasons why its balance-
of-trade deficit will not necessarily be corrected.
First, when a country’s currency weakens, its prices become more attractive to foreign
customers
Hence many foreign companies lower their prices to remain competitive.
Second, a country’s currency need not weaken against all currencies at the same time.
Therefore, a country that has a balance-of-trade deficit with many countries is unlikely
to reduce all deficits simultaneously.
EXAMPLE
Document Summary
Why exchange rates may not correct a balance-of-trade deficit. Once the country"s home currency"s value declines in response to these forces, the result should be more foreign demand for its products. If the value of the dollar does not weaken in such circumstances, a floating exchange rate will not correct the u. s. balance-of-trade deficit. Even if a country"s home currency weakens, there are several reasons why its balance- of-trade deficit will not necessarily be corrected. The country"s home currency"s value declines in response to these forces, the result should be more foreign demand for its products. A floating exchange rate will not correct any international trade imbalances when there are other forces that offset the effects of international trade flows on the exchange rate. Since the united states normally experiences a large balance-of-trade deficit. International trade flows should place downward pressure on the dollar"s value.
