Tuesday, February 9, 2016

Bill Mitchell — Is exchange rate depreciation inflationary?

One of the first things that conservatives (and most economists which is typically a highly overlapping set) raise when Modern Monetary Theory (MMT) proponents suggest that increased deficits are essential to reduce mass unemployment is the so-called balance of payments constraint. Accordingly, we are told that the capacity of a nation to increase domestic employment is limited by the external sector. And these constraints have become more severe in this age of multinational firms with their global supply chains and the increased volume of global capital flows. I will address the specific issue of a balance of payments constraint on real GDP growth (that is, the limits of fiscal stimulus) in a future blog. But today I want to consider the so-called Exchange Rate Pass-Through (ERPT) effects of that are part of the balance of payments constraint story. The mainstream narrative goes like this. Higher wage demands associated with full employment and/or stronger imports associated with higher fiscal deficits lead to external imbalances due to rising imports and loss of competitiveness in international markets (eroding export potential). In a system of flexible exchange rates, the currency begins to lose value relative to all other currencies and the rising import prices (in terms of the local currency) are passed-through to the domestic price level – with accelerating inflation being the result. If governments persist in pursuing domestic full employment policies the domestic inflation worsens and the hyperinflation is the result, with a chronically depreciated currency. Real standards of living fall and a general malaise overwhelms the nation and its citizens. I am sure you have heard that narrative before – it is almost a constant noise coming from the deficit phobes. Like most of the conservative economic claims and I include the austerity-lite Leftist parties in this group, it turns out that reality is a bit different. Here is some discussion on that issue.…
Bill Mitchell – billy blog
Is exchange rate depreciation inflationary?
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

1 comment:

Matt Franko said...

"The conventional wisdom is that when the, say Australian dollar, depreciates, the prices of all imported goods rise in local currency terms,"

Should be: When the exporters of goods to Australia raise their prices in AUD terms, the AUD depreciates.

Things just dont "happen!"...

"the Australian dollar went down!" ???????

"it just DID!!!" ??????

"it did it!!!" ??????

"its weak!!!!" ????

"its goin' down!!!!" ?????