Currency depreciation doesn’t offset tariffs

One of my few remaining thoughtful commenters (ChrisA) left the following comment:

On the UK exports being affected by tariff’s after Brexit – couldn’t that be taken care of by a fall in the pound vs the Euro? I don’t actually think a tariff war between the UK and the EU is actually going to happen, since the trade deficit is so much in favour of the EU they have a strong incentive to be sensible. But even in the worst case we couldn’t be talking about tariffs of more than 10%, which is easily taken care of by the fall in the pound that has happened over the last week. And remember that applies to all of the exports of the UK to all of the world, not just to the EU.

I see this claim quite often, but it doesn’t hold up to close scrutiny.  Tariffs on imports are essentially a tax wedge on trade, which reduces both imports and exports.  When people talk about using “currency depreciation” as a policy tool, they are often referring to an expansionary monetary policy.  However, although monetary stimulus does reduce the nominal exchange rates in both the short and long run, it only reduces the real exchange rate in the short run, until wages and prices have adjusted.  After that, the price level rises to restore the previous real exchange rate.

There’s no getting around the fact that trade barriers make economies less efficient, by diverting output from the tradable to the non-tradable sector.  This conclusion is not affected by whether the UK has a trade surplus or deficit, so I don’t agree that the EU has an “incentive to be sensible”.  Indeed, an import tariff might well reduce exports by just as much as it reduces imports, even if one’s trading partners do not retaliate.

Some commenters also criticized claims of a skilled labor shortage in Spain.  Over at Econlog, I have a new post that explains why they are wrong.


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31 Responses to “Currency depreciation doesn’t offset tariffs”

  1. Gravatar of Mike Sax Mike Sax
    2. July 2016 at 09:08

    Sort of a weird moment as some liberals say they like what Trump said about trade or at least think he identified a real problem-with wrong solutions.

    I’m not one of those liberals. I for one don’t like anything Trump says. But here’s Jared Bernstein:

    “As he always does, Trump conflates swagger with an actual plan. In this case, however, he’s pointing to a real problem. We can and should have a moratorium on trade agreements. The process by which they’re negotiated is undemocratic, they uplift investor rights over sovereign rights, they reverse the order in which certain challenges should be tackled, and they fail to deal with currency issues.”

    “But globalization cannot nor should not be stopped. Done right, it delivers great benefits to advanced countries through the increased supply of goods, and it helps improve the living standards of workers in developing countries through profits made from trade with wealthier nations. Trump’s tariffs would undermine all of that.”

    “When trade partners manipulate their currency, two negative effects follow. First, with the terms of trade artificially tilted against us, countries with large and persistent trade surpluses subsidize a flood of imports into the United States while unfairly pricing our goods out of their markets. Second, when, in the process, trade-surplus countries send large amounts of their dollar reserves back here, that gives rise to underpriced credit, bubbles, and, ultimately, recessions.”

    “Yes, we get cheap imports out of the deal, but people aren’t just consumers. They’re workers, too, and the cost of persistent trade deficits in terms of job losses and the economic “shampoo cycle” — bubble, bust, repeat — makes this a raw deal.”

    http://www.vox.com/2016/7/1/12080974/trump-free-trade-proposal

    Even Larry Summers is now talking about the need for a ‘responsible nationalism.’

    “The political challenge in many countries going forward is to develop a “responsible nationalism.” It is clear that there is a hunger on the part of electorates, if not the Davos set within countries, for approaches to policy that privilege local interests and local people over more cosmopolitan concerns. Channeling this hunger constructively rather than destructively is the challenge for the next decade. We now know that neither denying the hunger, nor explaining that it is based on fallacy, is a viable strategy.”

    https://www.washingtonpost.com/news/wonk/wp/2016/06/24/whats-crucial-to-know-the-morning-after-brexit/

    Now in total dissonance Newt Gingrich is in a Holy War against Nafta.

    http://www.politico.com/story/2016/07/newt-gingrich-trump-trade-vice-president-225035

  2. Gravatar of Mike Sax Mike Sax
    2. July 2016 at 09:09

    In fact in 2016, the Democrats in theory may be the more pro trade party. At least if Obama and Hillary have anything to say about it.

    They are under a lot of pressure to scrap TPP though.

    https://www.washingtonpost.com/news/post-politics/wp/2016/06/29/obama-and-sanders-battle-over-tpp-and-the-democratic-platform/

  3. Gravatar of Mike Sax Mike Sax
    2. July 2016 at 09:12

    In the good news is no news section, the 99% had their best year since Bill Clinton was President.

    “The 99 percent just had its best year in nearly two decades.”

    “The vast majority of American workers are finally seeing their incomes rise from the depths of the Great Recession, a new analysis from one of the world’s leading scholars of economic inequality suggests. But incomes for the top 1 percent continue to rise substantially faster.”

    “The analysis of Internal Revenue Service data on pre-tax earnings, from UC-Berkeley economist Emmanuel Saez and published by the Washington Center for Equitable Growth think tank, finds incomes increased by 3.9 percent last year for the bottom 99 percent of U.S. families. That’s the strongest growth those workers have seen since 1998, but it’s still not enough to repair all the damage the recession wrought on those workers: As Saez notes, those families on average have only regained two-thirds of the income they lost during and after the financial crisis.”

    “The top 1 percent, in contrast, have now regained almost all the income they lost during the recession. Their incomes grew by 7.7 percent, almost double the rate of the bottom 99 percent of workers, in 2015. Other work this spring has also suggested typical worker income growth is accelerating, including an analysis by former Clinton administration economic adviser Rob Shapiro that finds mounting income gains for young workers in particular in recent years.”

  4. Gravatar of am am
    2. July 2016 at 10:03

    What about from now to when brexit takes place or something else major happens. The now is a depreciated currency, overnight, by about 8 per cent, against the euro. Britain is still in the EU area so no tariffs apply. The tarrifs cannot apply til they actually leave in at least two years time. With the depreciated currency does it gain.
    Any dollar based exports are also benefitting from the pound to dollar depreciation.
    It seems there is the now from now til actual brexit. Call it the short run. After brexit there is the possibility of tariffs. This is more long run.

  5. Gravatar of ssumner ssumner
    2. July 2016 at 10:27

    Mike, Not clear why you are wasting your time here.

    AM, This depreciation seems have have mostly reflected the real shock of the Brexit vote, not monetary stimulus.

  6. Gravatar of Mike Sax Mike Sax
    2. July 2016 at 11:01

    “Mike, Not clear why you are wasting your time here.”

    Not sure what led to that hostile reaction, Scott. Certainly wasn’t being rude.

    Even if you are going out of your way to insult me, I won’t rise to the bait. I do enjoy reading your blog sometimes among a number of others. That I like reading it has no impact on whether you like me reading it I guess.

    I was just pointing out that the politics is turning against trade. I wasn’t saying this was a good thing just pointing it out .

    Even if you are gratuitously insulting to me for no reason at all, I can still admit I feel that I’ve learnt something from reading your blog on occasion.

  7. Gravatar of Mike Sax Mike Sax
    2. July 2016 at 11:07

    While I wouldn’t say you’re a stupid guy, Scott, you are maybe not such a nice guy.

    After all, I don’t worry about you calling me an idiot as I know I’m not.

    But what if I didn’t know that? What if I doubted my own basic intelligence?

    To deliberately try to insult someone for no good reason makes you look small.

  8. Gravatar of Ray Lopez Ray Lopez
    2. July 2016 at 11:19

    Sumner: “There’s no getting around the fact that trade barriers make economies less efficient, by diverting output from the tradable to the non-tradable sector.” – yes, but the US North during the 19th century had tariffs and indeed the US government got much of its revenue from these tariffs, used some of the revenue to promote infrastructure (canals, railroads, bridges, etc) and the US North became a powerhouse. Oh, they also were largely on a hard money standard, with a lot of free banking, except in the US Civil War when the North printed fiat money (that amazingly it later paid in full). That’s history, but I’m sure Sumner has an “Alt-History” view of things.

  9. Gravatar of James Alexander James Alexander
    2. July 2016 at 11:42

    Scott/AM
    Funny sort of real shock when the “shock” is something that may, possibly, have an impact, depending on negotiations, possibly after at least two years, probably more. Seems very strange to price in the worst case today.

    There may be upside if unilateral free trade were adopted, though this might only mean higher RGDP and lower NGDP.

  10. Gravatar of James Alexander James Alexander
    2. July 2016 at 11:49

    Krugman seems to agree:
    http://krugman.blogs.nytimes.com/2016/07/02/more-on-the-short-run-macroeconomics-of-brexit/?smid=tw-nytimeskrugman&smtyp=cur&_r=0

  11. Gravatar of ssumner ssumner
    2. July 2016 at 12:32

    Mike, You said:

    “Certainly wasn’t being rude.”

    Yes, you were. I’ve told you many times not to leave comments here. You continue to do so. That’s rude. You have your own blog—why fill up my comment space with one useless comment after another, none of which have any bearing on this post. The purpose of comments is to comment on the post itself, not to provide a platform for your random uniformed thoughts on trade.

    Ray, Please don’t go away. At least your comments are often funny.

    James, I think Krugman is right that most economists do overrate the “uncertainty” shock for the UK. But I do think there is an adverse demand shock for the eurozone. At least the asset markets responded as if the eurozone had been hit by an adverse demand shock—right?

  12. Gravatar of Mike Sax Mike Sax
    2. July 2016 at 13:02

    ” I’ve told you many times not to leave comments here. You continue to do so.”

    You had one time said that a long time ago. Since then we had many times had civil conversations and you’d even linked to material I’d left.

    So at best it’s been a mixed message.

  13. Gravatar of James Alexander James Alexander
    2. July 2016 at 13:07

    I don’t know if there is a demand shock in the Euro Area. Hard to see why. Is the UK so crucial to the EU success? It’s not even in the Euro.

    Lars makes a fuss about “regime uncertainty”. There is always more or less regime uncertainty out there, it’s the nature of “the future”. There are measures out there but seem a bit pseudo-scientific. Certainly, uncertainty is already quite high in the EU and especially the Euro Area. It may have gone a bit higher post the Brexit vote, but over-reaction seems the more likely reason than demand shock.

    Politicians were shocked, and in the labyrinthine EU they were shocking in their anti-UK vitriol. Destabilising, even. Divorce can sometimes generate more heat than light. Calmness is gradually returning.

  14. Gravatar of Mike Sax Mike Sax
    2. July 2016 at 13:12

    Last thing I’ll stipulate. Those were not my ‘uninformed views on trade’ above.

    They were the views of Larry Summers and Jared Bernstein.

    I wasn’t agreeing with them, just pointing out that trade is under a lot of political attack right now. I’m not saying I think that’s a good thing, But that’s what it is.

    So I didn’t share my ‘uniformed views’ or any views at all.

    I’ve seen many other readers deviate from the topic much more than I did above.

    You mentioned currency shocks here and Bernstein was talking about ‘stopping currency manipulation’ so that was the connection

  15. Gravatar of James Alexander James Alexander
    2. July 2016 at 13:20

    It’s also ironic that the most legitimate concerns about Brexit in the UK are all about lost work and investment to the rest of the EU as global business relocates to inside a future, potentially, ex-UK Single Market. If UK RGDP expectations have gone down then this is the cause as talking and listening to a wide variety of people in UK business this is their fear. If true, then this should be an RGDP expectations boost to EU ex-UK.

  16. Gravatar of Justin Justin
    2. July 2016 at 14:44

    Yes, and for similar reasons I’ve never been convinced by the idea that Germany benefits from being in a currency union with weaker partners. Germany exports a lot because they make quality, over engineered products at a relatively low price. You can’t scam your way to being an export powerhouse.

  17. Gravatar of Ray Lopez Ray Lopez
    3. July 2016 at 01:17

    Yes, Mike Sax left a thoughtful response and Sumner butchered him. Sumner’s bipolar, seems he likes me but not Sax. Strange.

    BTW, specifically on the topic of this post: the idea that currency depreciation does not affect trade except in the short term (Sumner: “When people talk about using “currency depreciation” as a policy tool, they are often referring to an expansionary monetary policy. However, although monetary stimulus does reduce the nominal exchange rates in both the short and long run, it only reduces the real exchange rate in the short run, until wages and prices have adjusted. “), true, but in the long-run we are all dead. Most politicians think of the short term only, and Japan and China have spent decades wasting money with either currency interventions (Japan) and/or currency exchange ratios that are unrealistic, and hurt savers (China). Pols respond to voters who respond to short-term pain much more than long term gain. Try telling a laid-off factory worker than someday his kids or his neighbor’s kids will be richer due to free trade and you’ll get a raspberry boo.

    So while yes, money is neutral in the long run (and often in the short run) most people don’t think that’s all that important.

  18. Gravatar of Mike Sax Mike Sax
    3. July 2016 at 03:16

    Maybe Scott sees me not as a commentator but as a competitor because I have a blog, that gets a decent amount of traffic, it’s true. In fact this last month was a record.

    Again, unlike you Scott, I don’t have to be uncharitable as I lack your insecurities.

  19. Gravatar of Mike Sax Mike Sax
    3. July 2016 at 03:19

    I say insecurity as if you were really out of my league intellectually I wouldn’t get under your skin.

  20. Gravatar of Mike Sax Mike Sax
    3. July 2016 at 03:22

    Regarding my blog, many Money Illusion commentators have been turned onto it once they became aware of it.

    Scott is a good economist I agree. But he doesn’t know politics. He never thought Trump could win the GOP primary and I called it since last Summer.

    So those who want better political analysis might be tempted to come hang with me, I agree.

    Maybe that’s the source of your insecurity?

  21. Gravatar of Mike Sax Mike Sax
    3. July 2016 at 03:36

    Another reason Scott is so insecure: we lay people give Scott credit for being an economist, but among other economists he’s sort of the Donald Trump of economists.

    Real billionaires don’t spend a lot of time thinking about Donald Trump

  22. Gravatar of ChrisA ChrisA
    3. July 2016 at 04:18

    Well I’m blushing.

    On your response, I agree in the long run, wages etc will catch up with the devaluation, but of course in the long run we are all dead….notably in the EU it seems like countries like Italy or Greece need a much lower currency to prosper, but this is years since they moved to the EU. Why hasn’t their wages adjusted instead?

    On the incentives of the EU to be sensible – I am not really understanding you. My take was simple, the EU, especially Germany exports lots of expensive cars to the UK, in fact I believe the UK is their biggest market. But the UK exports a lot less to Germany. So if both sides unilaterally imposed sanctions of the same amount (in a tit for tat approach) surely the Germans would see the bigger hit in terms of lost market share for their automobile makers? So yes both sides lose, but at least in tangible short term impacts, the German auto makers lose most. And politics should be informed by that surely? So we can expect that German automakers will lobby the EU negotiators to be sensible surely. I guess I am not making an economic argument but a political one.

    On tariffs in general, of course I agree they are a bad idea and I would argue that the UK make them zero even if the EU applied tariffs on it’s exports. But I have a suspicion that the benefits of participation in customs unions are not actually important in what drives the growth in countries. Or to put it another way, the quality of institutions and people in a country are much more important in terms of how wealthy a country is versus whether or not it has favourable tariffs on its exports. We can easily see this in the EU itself, where, say, Greece is very much poorer than Germany despite the fact that they are both tariff free traders.

  23. Gravatar of Mike Sax Mike Sax
    3. July 2016 at 05:30

    Ray Lopez, thanks for stopping by. You’re comments led to this post.

    http://lastmenandovermen.blogspot.com/2016/07/the-donald-trump-of-billionaires.html

    You’re comments are always welcome there and I won’t even condescend to you like Scott does.

    An added bonus-it will irritate him.

  24. Gravatar of am am
    4. July 2016 at 07:34

    JA.
    I was just asking if there were any current account benefits for the UK before actual brexit and with the now depreciated currency.

  25. Gravatar of am am
    4. July 2016 at 08:18

    https://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments
    Latest position prior to vote.

  26. Gravatar of ssumner ssumner
    4. July 2016 at 12:29

    James, You said:

    “I don’t know if there is a demand shock in the Euro Area. Hard to see why. Is the UK so crucial to the EU success? It’s not even in the Euro.”

    That’s not the issue, the worry was that Brexit would lead to similar problems in the PIGS. That would have a contagion effect.

    Ray, Your mistakes are funnier than Mike’s.

    ChrisA, The standard view is that when a small country (say the UK or Mexico) borders a big economy, say the US or EU) the small country has much more to gain from free trade.

    I agree that free trade zones don’t have a dramatic impact on growth, but I’d note that the bond market is clearly signaling lower growth in the UK, going forward.

  27. Gravatar of Pyrmonter Pyrmonter
    4. July 2016 at 21:05

    Do prices, and in particular, wages adjust to offset currency depreciations? When I was taught undergraduate macro that was one rather depressing approach to the Australian economy: it was said that we had real wages pegged (downwardly at least) to the real exchange rate: several examples from the 70s and mid 1980s used to be cited.

    But since inflation was (practically) eliminated and wage fixing returned to something much closer to market mechanisms (enterprise bargaining rather than traditional state-sponsored aribtral awards) at the beginning of the 1990s, there have been several steep depreciations of the AUD, none of which has been accompanied by a “break out” of wage inflation; ajdustment has, instead, been through trade volumes.

  28. Gravatar of ssumner ssumner
    5. July 2016 at 08:24

    Pyrmonter, It depends why the exchange rate changes. If due to real factors, then inflation does not offset the effect. If due to monetary policy, then inflation does offset the effect.

  29. Gravatar of daws daws
    6. July 2016 at 11:46

    are tariffs more efficient than taxes on labor and capital income?

  30. Gravatar of Floccina Floccina
    6. July 2016 at 13:26

    Isn’t that an example of the fact that accelerating inflation drives up employment and decelerating inflation drives employment down? People are only fooled by unexpectedly high inflation.

  31. Gravatar of ssumner ssumner
    7. July 2016 at 14:30

    Daws, No.

    Floccina, What you say is true, but I’m not sure it applies to this case.

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