How can a weak dollar be beneficial?

[tyler_cowen]

Originally posted on October 22, 2009.

I'm still receiving email pushback on my view that a falling dollar can be good for the U.S. economy.  The critics charge: why not just let the dollar fall close to zero or at least hope for such?  A few points:

1. I'm not asking for a specific weak dollar policy (we've already done enough on that front!).  The point is that if the market brings a falling dollar, this outcome can be part of the equilibrating process.

2. You don't have to approve of all the policies, or private sector practices (e.g., a low savings rate) that produced the weak dollar.  A weak dollar is still a healthy response, given those constraints.

3. Never forget the difference between real and nominal exchange rates.  That answers the conundrum about wishing for a dollar of near-zero value.

4. A falling dollar will (often, not always) increase employment in the export sector.  Supply-side, production-based multipliers are the best kind to have and they can outweigh the economic costs of higher import prices.  When the dollar falls, a big chunk of that shift is born by foreign exporters like a tax rather than being passed along to U.S. consumers.  The net effect is that Mercedes-Benz subsidizes job creation in the United States.  And sometimes a falling currency is in fact an efficient form of lump sum taxation in this regard.

5. Free traders are usually economic cosmopolitans, which is good.  A weak currency in one country means a strong currency in another and the distribution effect, at least at the first-order level of analysis, is a wash.  So cosmopolitanites shouldn't object to weak currencies per se.  From a global point of view, a lot of currency movements are close to a net wash in efficiency terms, although they may be good for at least one of the countries in the equation.  As a rough rule, weak currencies do the most good where resources are unemployed and there is a realistic elasticity of exports, though it is more complicated than that.

6. A weak dollar poses the biggest problems for the EU and other foreign regions.  Still you can see those as real problems and think a falling dollar is OK for the U.S., taken alone.

7. Again: blah-blah-blah caveats about the difference between a currency falling as a pure thought experiment and a currency falling as associated with some particular cause.  Blah, blah, blah, etc.  Blah.

Daniel Drezner offers related commentary.