Devaluing the dollar: A critical analysis of William Cline's case for a New Plaza Agreement

Abstract

In his new book “The United States as a Debtor Nation” William Cline estimates that a 28% real effective real depreciation of the U.S. dollar would reduce the U.S. current account deficit from a projected 7.5% of GDP to 3% of GDP. We argue that his projection, which is based on an elasticities model of the U.S. balance of trade, is highly misleading. First downward deflationary pressure on overall foreign price levels from currency appreciation is not incorporated. Second, the negative impact of appreciation on foreign income and absorption is absent. Third, complementary and necessary adjustments in monetary and fiscal policies in the U.S. and its trading partners are not explicitly incorporated into Cline's econometric framework. We conclude that the impact of massive dollar devaluation on the U.S. trade deficit would be ambiguous, but that the macroeconomic stability of the world economy could be seriously undermined.