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Monthly Report - Focus
Growth in the US breaks free from the dollarGrowth in the US breaks free from the dollar

Since the middle of last year, the dollar has appreciated by around 10% compared with a broad basket of currencies (see the first graph).1 A large part of its strength comes from monetary policy that is comparatively more restrictive in the US than in other regions in the world given the United States' better growth prospects. Nevertheless, this strong appreciation of the dollar has aroused some concern regarding its potentially harmful effect on US exports and consequently on economic growth.

In the medium term, an appreciation in the exchange rate leads to a decrease in exports (because they are less attractive in price terms) and to an increase in imports (for the opposite reason), in turn reducing GDP growth. For example, according to the FRB/US general equilibrium model employed by the Federal Reserve (Fed) for  forecasting and the analysis of macroeconomic issues a 10% appreciation in the dollar cuts growth by 0.5 pps after four quarters and by 0.75 pps after the second year.

Although the model used by the Fed is sound, it is notable that members of its own Federal Open Market Committee (FOMC) have recently stressed they expect the effect of the exchange rate on GDP growth to be less than on previous occasions. A variety of factors could lead to the dollar having less impact on economic growth. These include the change in the country's type of exports, which are technologically more advanced and therefore less sensitive to price changes, for example; or exports that are more thoroughly integrated within global value chains and therefore less affected by the dollar's appreciation thanks to imports of cheaper intermediate inputs.

Whatever the reason, a simple exercise confirms that the view of the FOMC members is well-founded and that, in fact, this change in the sensitivity of exports to the exchange rate seems to be considerable in quantitative terms. This can be seen in the second graph which relates the change in exports of goods and services with the change in the exchange rate over two different time periods: 2011-2014 and 1970-2010. To estimate this relationship, other key factors affecting the trend in exports are also taken into account, such as global demand (via GDP growth in OECD countries). As can be observed, not only have exports become less sensitive to the exchange rate but their sensitivity has almost halved.2

In short, although the dollar's appreciation is due to a relatively more restrictive monetary policy, it also reflects the greater advances in economic activity and better prospects for the US than other regions such as Japan and the euro area. Although the loss of competitiveness resulting from such an appreciation reduces growth in the medium term, the recent decrease in the sensitivity of US exports to its exchange rate will lessen this effect on the economy.

1. According to BIS data, in nominal effective terms there has been an appreciation of between 11% and 14%, depending on whether a more or less extensive basket of currencies is used, respectively. In real effective terms (i.e. controlling inflation differences in various countries), it has appreciated by almost 10%.

2. The change in sensitivity of exports to the exchange rate is statistically significant.

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