Escalating trade tensions are taking a toll on the global economy and are partly responsible for the recent downward revisions to our growth forecasts for 2019-20.
Facing sluggish growth and below-target inflation, many advanced and emerging market economies have appropriately eased monetary policy, yet this has prompted concerns over so-called beggar-thy-neighbor policies and fears of a currency war. In this blog post, we discuss the implications of recent policy actions and proposals and offer alternative ways to address concerns over trade imbalances that are much more supportive of global growth.
To be sure, the adjustment becomes more balanced over time as exports respond more meaningfully to exchange rate movements, although the full expenditure switching effect remains relatively modest: a 10 percent depreciation leads, on average, to a 1.2 percent of GDP improvement in the trade balance over a span of three years. So, while exchange rates facilitate durable external adjustment, the expenditure switching effect of a currency weakening, or its negative impact on trading partners, should not be overplayed.