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How do currency policies even work? Isn't it like the state forcing exporting and tourism companies to lower their prices (by devaluating the currency)? Why is

How do currency policies even work? Isn't it like the state forcing exporting and tourism companies to lower their prices (by devaluating the currency)? Why is that the states job instead of the individual companies'? Also the state can scam buyers of state bonds by inflating the currency, which also has the sideeffect of meddling with it's own economy. It's not a silver bullet, it's just different cancer.

bainsfather 7y ago
"Isn't it like the state forcing exporting and tourism companies to lower their prices (by devaluating the currency)? Why is that the states job instead of the individual companies'?" With a free-floating currency, prices for foreign buyers can change overnight. This can allow quick responses to shocks. In contrast, internal devaluation (deflation) is a very slow process (how do you coordinate everyone in a country to reduce their prices). e.g. for the UK circa 2008 the economy had problems (more reliant on finance sector than most other countries) and the currency dropped, making UK exporters more competitive. Italy or Greece a few years later would have also seen their currencies fall, had they not been locked into the same currency as Germany. Instead, their exporters have problems with competitiveness which take many years to equilibrate (they must have lower inflation or deflation relative to Germany). There is a subject called 'Optimum Currency Areas'. As always, there are tradeoffs, more homogeneous economic areas face this particular problem less and so are more likely to benefit from a single currency.
- vnorilo 7y ago
  Thank you for the insights. Any thoughts on how it went down in Latvia, sometimes cited as a success story but also criticized [1]? [1]: http://cepr.net/publications/reports/latvias-internal-devaluation-a-success-story http://cepr.net/publications/reports/latvias-internal-devalu...
  - bainsfather 7y ago
    I am sorry, no. I do not have such expertise. When I read economics textbooks, I see a marked contrast to physics textbooks. e.g. in physics, they might explain about a pendulum using equations etc, but then they show you real experimental data, to show that your equations about period vs pendulum length are correct. I have not found economics textbooks that do that. The more basic thing that economics gives me is akin to this: when iron ships were first proposed, sceptics might say 'iron sinks, so iron ships are impossible, you are crazy'. You can answer this by putting an iron saucepan in the kitchen sink, and showing that it floats. So (macro) economics can tell me some basic things about 'which way is up'. But putting even half-accurate numbers on things is difficult. imo economics is often done best when you view it using historical case studies + theory to know which way each effect acts. This is not to say that what you ask is impossible, but when that is done (by experts, not me), it is not convincing enough to convince others that it is right.
- Double_a_92 7y ago
  > Instead, their exporters have problems with competitiveness which take many years to equilibrate (they must have lower inflation or deflation relative to Germany). Then why don't they lower their prices? Why do they need to rely on a devaluating currency (which might come automatically from the market, or from the central bank actively buying foreign currency at high price)?
  - bainsfather 7y ago
    So, you need to lower all prices - i.e. as an exporter you ask your workers to take wage cuts, they must ask their landlords to reduce their rents, shopkeepers to reduce prices etc. This is a slow process (especially because many contracts run for a fixed period so cannot be changed until the next contract is signed). Internal devaluation can be done, it is just a slow and painful process (usually including higher unemployment).
imtringued 7y ago
Currency devaluation happens automatically regardless of government intervention. Where did you get the idea that it's just a currency policy? Currency devaluation and appreciation are purely market driven depending on supply and demand. If you have two countries trading with each other and one of them has a surplus like the trade between Germany and Greece. Greece has to borrow money from Germany for a surplus to happen. The market automatically compensates for this. What happens is that the demand for the German currency shoots up and demand for the Greek currency goes down. This means that eventually German products are no longer affordable because the Greek currency has been devalued and Germany won't lend money to Greece anymore because they can't pay it back. This also means that suddenly Greek labor is much cheaper than German labor despite the productivity gap. Therefore there is now an incentive to start more Greek businesses. Anyway the takeaway is that there is an upper bound to how much Greece can borrow from Germany before local industry becomes more cost effective. The goal is to trade as much as possible but to also support the local economy. Now the same scenario with the Euro results in no appreciation or devaluation. Greece borrows money from Germany. The exchange rate doesn't change because it's the same currency. Greece's ability to repay the loan did not change but there is now no economic pressure to not lend money. Greece can lend as much as it wants and since German products are always more cost effective it will use that borrowed money to always buy German products. The local economy languishes and eventually Greece has borrowed so much that it can't pay off it's debt. Then all you need to do to finish off Greece is to launch some kind of austerity policy that decimates what little local economy has managed to survive. There is no working solution for the problems a unified currency causes. The best thing that one could possibly do is to have transfer payments to cancel the surplus but there is no way to force people to spend that money in the local economy and there is still the perverse incentive to increase the surplus to get more transfer payments.
- Double_a_92 7y ago
  > Where did you get the idea that it's just a currency policy? Not just, but it is. E.g. Switzerland has actively tried for years to peg 1.20 CHF to 1 EUR, to ensure that exports would not be hurt by a strong CHF. ... Until it suddenly didn't anymore.

bainsfather 7y ago

"Isn't it like the state forcing exporting and tourism companies to lower their prices (by devaluating the currency)? Why is that the states job instead of the individual companies'?" With a free-floating currency, prices for foreign buyers can change overnight. This can allow quick responses to shocks. In contrast, internal devaluation (deflation) is a very slow process (how do you coordinate everyone in a country to reduce their prices). e.g. for the UK circa 2008 the economy had problems (more reliant on finance sector than most other countries) and the currency dropped, making UK exporters more competitive. Italy or Greece a few years later would have also seen their currencies fall, had they not been locked into the same currency as Germany. Instead, their exporters have problems with competitiveness which take many years to equilibrate (they must have lower inflation or deflation relative to Germany). There is a subject called 'Optimum Currency Areas'. As always, there are tradeoffs, more homogeneous economic areas face this particular problem less and so are more likely to benefit from a single currency.

vnorilo 7y ago
Thank you for the insights. Any thoughts on how it went down in Latvia, sometimes cited as a success story but also criticized [1]? [1]: http://cepr.net/publications/reports/latvias-internal-devaluation-a-success-story http://cepr.net/publications/reports/latvias-internal-devalu...
- bainsfather 7y ago
  I am sorry, no. I do not have such expertise. When I read economics textbooks, I see a marked contrast to physics textbooks. e.g. in physics, they might explain about a pendulum using equations etc, but then they show you real experimental data, to show that your equations about period vs pendulum length are correct. I have not found economics textbooks that do that. The more basic thing that economics gives me is akin to this: when iron ships were first proposed, sceptics might say 'iron sinks, so iron ships are impossible, you are crazy'. You can answer this by putting an iron saucepan in the kitchen sink, and showing that it floats. So (macro) economics can tell me some basic things about 'which way is up'. But putting even half-accurate numbers on things is difficult. imo economics is often done best when you view it using historical case studies + theory to know which way each effect acts. This is not to say that what you ask is impossible, but when that is done (by experts, not me), it is not convincing enough to convince others that it is right.
Double_a_92 7y ago
> Instead, their exporters have problems with competitiveness which take many years to equilibrate (they must have lower inflation or deflation relative to Germany). Then why don't they lower their prices? Why do they need to rely on a devaluating currency (which might come automatically from the market, or from the central bank actively buying foreign currency at high price)?
- bainsfather 7y ago
  So, you need to lower all prices - i.e. as an exporter you ask your workers to take wage cuts, they must ask their landlords to reduce their rents, shopkeepers to reduce prices etc. This is a slow process (especially because many contracts run for a fixed period so cannot be changed until the next contract is signed). Internal devaluation can be done, it is just a slow and painful process (usually including higher unemployment).

imtringued 7y ago

Currency devaluation happens automatically regardless of government intervention. Where did you get the idea that it's just a currency policy? Currency devaluation and appreciation are purely market driven depending on supply and demand. If you have two countries trading with each other and one of them has a surplus like the trade between Germany and Greece. Greece has to borrow money from Germany for a surplus to happen. The market automatically compensates for this. What happens is that the demand for the German currency shoots up and demand for the Greek currency goes down. This means that eventually German products are no longer affordable because the Greek currency has been devalued and Germany won't lend money to Greece anymore because they can't pay it back. This also means that suddenly Greek labor is much cheaper than German labor despite the productivity gap. Therefore there is now an incentive to start more Greek businesses. Anyway the takeaway is that there is an upper bound to how much Greece can borrow from Germany before local industry becomes more cost effective. The goal is to trade as much as possible but to also support the local economy. Now the same scenario with the Euro results in no appreciation or devaluation. Greece borrows money from Germany. The exchange rate doesn't change because it's the same currency. Greece's ability to repay the loan did not change but there is now no economic pressure to not lend money. Greece can lend as much as it wants and since German products are always more cost effective it will use that borrowed money to always buy German products. The local economy languishes and eventually Greece has borrowed so much that it can't pay off it's debt. Then all you need to do to finish off Greece is to launch some kind of austerity policy that decimates what little local economy has managed to survive. There is no working solution for the problems a unified currency causes. The best thing that one could possibly do is to have transfer payments to cancel the surplus but there is no way to force people to spend that money in the local economy and there is still the perverse incentive to increase the surplus to get more transfer payments.

Double_a_92 7y ago
> Where did you get the idea that it's just a currency policy? Not just, but it is. E.g. Switzerland has actively tried for years to peg 1.20 CHF to 1 EUR, to ensure that exports would not be hurt by a strong CHF. ... Until it suddenly didn't anymore.