ECON 20 Lecture Notes - Lecture 28: Aggregate Demand, Microeconomics
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Trade deficits and exchange rates: self correction?
● U.S. imports have been much higher than U.S. exports for some time. The gap declined
during the Great Recession period, but it remains large.
● This inflow of imports puts downward pressure on the dollar. The dollar's value will fall at a
modest rate over a long period of time. This would encourage U.S. exports and would
eventually lead to the closing of the gap between exports and imports.
● If this adjustment process is effective, exchange rate movements offset trade deficits over
time. Thus, the trade deficit has a tendency to “self correct.” As a practical matter, however,
the U.S. trade deficit has been quite persistent even as exchange rates have moved.
● Some economists, however, strongly believe that the trade deficit will eventually be closed
by movements in the exchange rate. This is another sense in which the currency may not be
correctly valued: a large trade deficit suggest a currency is over valued and will depreciate
10. Is a Strong Dollar Good or Bad for the U.S.?
● Note that the following arguments hold for any currency.
● A strong dollar increases the purchasing power of U.S. citizens buying foreign goods. In this
sense, a strong dollar makes Americans more “wealthy.” It increases their international
● A strong dollar tends to raise the trade deficit. Why? A strong currency raises imports
(which become cheaper for Americans) and lowers exports (which become more expensive
for foreigners). A bigger trade deficit raises foreign debt and, as discussed above, shifts the
burden of servicing higher debt to future generations.
● A strong dollar makes a country wealthier, but it can reduce AD (and therefore hurt growth
and employment through the demand side). A weak dollar is more likely to stimulate
aggregate demand and is often preferred by manufacturers who want to sell their output
abroad. For this reason, a strong dollar is usually viewed as bad for employment.
● A strong dollar is a signal of low inflation.
● A strong dollar is a signal of confidence in the U.S. economy.
● A strong currency makes it easier to service foreign debt (this argument does not apply to the
United States because its foreign debt is denominated in dollars).
A little economics humor from the original version of the lecture notes prepared by TA Jamie
Kucher several years ago: