Benn Steil


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Beware Friendly Fire in the Currency Wars

by Benn Steil and Dinah Walker
April 1, 2013


Prominent economic commentators have argued the cases for significantly weaker currencies in each of the world’s major economies – in particular, the United States, the eurozone, Japan, and the UK. As these four economies represent over half of the global economy, it’s clear that they can’t all accomplish this feat. It’s also far from clear that they should all want to.

Take the UK, where the FT’s Martin Wolf has led the charge for “further depreciation of the real exchange rate.” John Maynard Keynes, belying his reputation as a devaluationist, had argued passionately against a weaker pound in 1945 on the basis of terms of trade: that is, the UK would, broadly, have to give up more domestic goods in return for the same quantity of foreign goods. “In [our] circumstances, you can’t imagine anything more foolish,” he said, “than to be trying to sell [our] exports at quite unnecessarily low prices.” Today he might highlight inflation. As shown in today’s Geo-Graphic, currency depreciation is likely to have a much more adverse effect on inflation in the UK than in the United States, the eurozone, or Japan, owing to much higher imports relative to GDP. UK consumer price inflation is already running at a relatively high 2.8%, and the Bank of England’s own analysis suggests that a 20% sterling depreciation risks pushing the price level up 6 percentage points higher than it would otherwise be.

Steil: The Battle of Bretton Woods
Bank of England: Inflation Report February 2011
Wolf: Weaker Pound Is Welcome but No Panacea
Financial Times: Weakening Pound Raises Stagflation Fears

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  • Posted by J.G. Collins

    Its not likely Japanese inflation will be long belayed. Governor Kuroda’s implementation of “Abenomics” – somewhat ham-fisted – has aready led to higher import costs and even some inflationary expectations. (Kuroda has since retrenched and said that he will maintain price stability with YoY inflation at 2%, even though he will nearly double the monetary base by the end of 2014 and support increased government spending.)

    Recent research by the NY Fed has called for higher inflationary expectations as stimulus at the zero-bound, on the hypothesis that consumers will spend more given an inflationary expectation. That may or may not be true, but inflation would certainly help Japan manage a de facto partial default by reducing the relative value of the Yen that are to be repaid.

    One can only hope the yield on new Japanese government debt will be able to keep pace and within Governor Kuroda’s parameters. There could be deeply troubling consequences if it does not.

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