The Impact of a Dollar Depreciation on the Trade Balance of the United States
Running head: DOLLAR DEPRECIATION
The impact of a dollar depreciation on the trade balance of the United States
Mai Dam
Randolph College
2013
Abstract
The trade deficit is an issue of concern in the contemporary U.S. economy. While depreciation of the dollar is used as a means to improve the trade deficit, the delay in its taking effect creates a puzzle for economists. The theory of J-curve is used to explain this delay, stating that a period of time is needed for the deficit to get worse before becoming better. It also states the effect of domestic income and foreign income on the trade deficit. These relationships are tested in a growth rate model, allowing lags of 3 years. It is concluded that there is a lag time before the dollar depreciation has effects. An increase in domestic income worsens the trade deficit while an increase in foreign income lessens the trade balance.
The impact of a dollar depreciation on the trade balance of the United States
Since Adam Smith sparked the notion of open economies and trade, the world has gradually transformed its economic pattern towards a flatter world, where historical and geographical divisions are becoming increasingly irrelevant (Friedman, 2005). The establishment of the World Trade Organization in 1995, along with many regional trade agreements, boosted the growth of international trade and created the foundation on which country members negotiate their transactions. The world’s total exports of goods and services have increased by $16,418 billion from 1980 to 2010 (Economy Watch).
Despite the increasing competition from new developing economies such as China, the United States has always been considered as a leader in the global economy. Constituting 4.46% of the world population, the U.S. produces 18.2% of global manufacturing goods and consumes 29% of world products (World Trade Organization). However, the U.S. has been running consistent trade deficits since 1980 due to high
The impact of a dollar depreciation on the trade balance of the United States
Mai Dam
Randolph College
2013
Abstract
The trade deficit is an issue of concern in the contemporary U.S. economy. While depreciation of the dollar is used as a means to improve the trade deficit, the delay in its taking effect creates a puzzle for economists. The theory of J-curve is used to explain this delay, stating that a period of time is needed for the deficit to get worse before becoming better. It also states the effect of domestic income and foreign income on the trade deficit. These relationships are tested in a growth rate model, allowing lags of 3 years. It is concluded that there is a lag time before the dollar depreciation has effects. An increase in domestic income worsens the trade deficit while an increase in foreign income lessens the trade balance.
The impact of a dollar depreciation on the trade balance of the United States
Since Adam Smith sparked the notion of open economies and trade, the world has gradually transformed its economic pattern towards a flatter world, where historical and geographical divisions are becoming increasingly irrelevant (Friedman, 2005). The establishment of the World Trade Organization in 1995, along with many regional trade agreements, boosted the growth of international trade and created the foundation on which country members negotiate their transactions. The world’s total exports of goods and services have increased by $16,418 billion from 1980 to 2010 (Economy Watch).
Despite the increasing competition from new developing economies such as China, the United States has always been considered as a leader in the global economy. Constituting 4.46% of the world population, the U.S. produces 18.2% of global manufacturing goods and consumes 29% of world products (World Trade Organization). However, the U.S. has been running consistent trade deficits since 1980 due to high
References: Blanchard, O. (2005). Macroeconomics. Prentice Hall. Blecker, R. A. (1999). The Causes of the U.S. Trade Deficit. Trade Deficit Review Commission. Washington, DC. Friedman, T. (2005). The World Is Flat: A Brief History of the Twenty-First Century. Farrar, Straus and Giroux. Goldberg, L., & Dillon, E. W. (2007). Why a Dollar Depreciation May Not Close the U.S. Trade Deficit. Current Issues in Economics and Finance. Research Department of the Federal Reserve Bank of Chicago. (1985, November). Bringing down the Value of the U.S. dollar. International Letter. Research Department of the Federal Reserve Bank of Chicago. (1986, July). The Dollar-Trade Puzzle. International Letter.