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Should the United States devalue its currency and what would the global implications be?

Question submitted by Jason Thomas, May 14, 2013

Answered by: A. Michael Spence, Distinguished Visiting Fellow


The monetary policy of the Federal Reserve is focused on keeping short- and long-term interest rates low in order to stimulate domestic aggregate demand in two ways. First, it hopes to accelerate the deleveraging process by reducing interest costs and making it easier to pay off principal. Second, it seeks to raise asset values by lowering the discount rate, thereby increasing household wealth. The Fed's intent is not to devalue the currency, but this strategy does put downward pressure on the dollar relative to higher interest rate environments. It also depresses the return on savings, pushing savers into riskier assets.

Generally, to adopt an explicit goal of forcing the dollar down is not a good idea. The U.S. dollar remains the main reserve currency. Others would follow, especially the BRIC states, and the United States would get into a competitive devaluation scenario where there are no winners. The benefits of avoiding competitive devaluation are demonstrated in the recent case of Japan, in which the G20 accepted Japan's new aggressive monetary policy because of its weak economy. However, the G20 did not accept Japan's central bank acquiring external (non-yen) assets as reserves, which would have been an explicit way for the bank to intervene and prevent currency appreciation.

While currency devaluation might aid growth by making exports more competitive globally, today, supply chains are no longer simple and are scattered around the world. Most countries now import a fair amount of the export content of their goods and services, so the effect of a devaluation in competitive terms is more mixed than it used to be. Thus, devaluation makes imports more expensive, hurting consumers and aiding competitiveness less than one might think.

Generally, for advanced countries with deep and liquid capital markets like the United States, the best policy is to allow these markets to determine exchange rates.