The effects of depreciating dollar

A question from Yahoo! Answers:

What do you think are the effects of the depreciation of USD?

it would really help me if you have statistics to prove your statement…! you think it is helping to reduce the US trade deficit and did it cause inflation? This is for my Econ project and i’m kinda lost.

Domestically, there will be next to no visible effect. In 2006, imports accounted for about 18% of U.S. GDP (see the BEA national income data); on average, one percentage point increase in import (meaning, wholesale) prices leads to about 0.4 percentage point increase in the final consumer price (see Campa and Goldberg). So even if the U.S. dollar loses, say, 30% of its value, the additional inflation caused by it will be about (30% * 18% * 0.4) = 2.2%. Note that this would probably happen over a period of time greater than one year, so this 2.2% increase in price level will be spread over that entire period and annualized contribution to inflation will be smaller. Now throw in the likely increase in employment in export-oriented and import-competing industries…

As to reducing the trade deficit, this is already happening. As Paul Krugman recently put it,

Over the past year real exports are up about 10 percent, a lot faster than overall growth, while real imports are up only about 2 percent, slower than overall growth; all this is presumably the effect of the weak dollar, and there’s probably a lot more to come. Overall, the improving trade picture added about 1 percent to the economy’s growth rate, which is modest but significant.

So all in all, as a result of the declining dollar, the U.S. would probably have a small gain in economic growth at the expense of slightly higher inflation…

You should probably read up on the effects of the last dollar collapse, the one that happened in 1985-87…

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