Senior economists at the International Monetary Fund (IMF) have warned countries against relying too heavily on monetary policy easing, and argued that currencies are 'neither the hammer nor the nail' in efforts to reinvigorate economies.
Currency devaluation has become a focal point for global trade tensions. Earlier this month, the U.S. formally accused China of currency manipulation, while in June, President Donald Trump attacked ECB President Mario Draghi for the impact of his dovish comments on the value of the euro against the dollar.
"But one should not put too much stock in the view that easing monetary policy can weaken a country's currency enough to bring a lasting improvement in its trade balance through expenditure switching." A 10% depreciation on average improves a country's trade balance by around 0.3% of gross domestic product within a 12-month period, primarily through contracting imports, the note highlighted, since trade is largely invoiced in dollars.
The economists highlighted that tariffs and exchange rates work differently, insofar as a 10% tariff will not necessarily offset a 10% overvaluation in an exchange rate, and pointed to the example of recent developments in the U.S.-China trade war.
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