Inner devaluation

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An internal devaluation occurs when prices and wages fall in a country relative to the price level of other countries without a devaluation of the nominal exchange rate of the currency ( currency devaluation takes place).

theory

starting point

Countries with currencies that are linked to the euro or the US dollar:
  • United States of America
  • Other countries with US dollars as legal tender
  • Currencies with a fixed exchange rate peg to the US dollar
  • Currencies with a narrow exchange rate range to the US dollar
  • Members of the European Monetary Union with Euro
  • Other countries with euro as legal tender
  • Currencies with a fixed exchange rate peg to the euro
  • Currencies with a narrow exchange rate range to the euro

    • If a country is confronted with an external shock , with chronic trade deficits, or with the nominal overvaluation of its own currency, it will usually try to improve its international competitiveness through currency devaluation . Then imports become more expensive and exports cheaper. Trade deficits are decreasing. In the medium term, there will be a positive employment effect. However, the real increase in the price of imports leads to a falling standard of living. On the other hand, increasing exports can generate additional income for private households. Experience has shown that part of this additional income is spent on buying goods or services, which creates new income ( export multiplier ). Similarly, import substitution can generate additional income (also with a multiplier).

    Mechanisms

    The government and the central bank can generate internal devaluation (= internal devaluation) by pursuing a restrictive fiscal policy and a policy of wage and price restraint through appeals and, if necessary, legal measures (e.g. the prohibition of monetary value protection clauses in contracts). The central bank supports internal devaluation by means of a high interest rate policy or a limited supply (towards the credit institutions) of liquid funds (see also discount policy ).

    Differentiation from currency devaluation

    A devaluation will usually take place through currency devaluation (e.g. through foreign exchange market intervention ). With an unchanged or unchangeable exchange rate relationship (with a fixed exchange rate or within a currency union), an internal devaluation basically has the same competitive effect as a currency devaluation, the products and services of one country are cheaper than those of other countries in international comparison, which increases competitiveness . However, an internal devaluation is more difficult to carry out than a devaluation of the currency, because the change in all prices and wages i. d. Usually leads to distribution struggles. According to Milton Friedman , it is much easier to change the exchange rate than thousands of contracts with wages and prices. According to Keynesian theory, it is also more difficult and cost-intensive to adjust prices downwards than to increase prices. According to a view that is widespread in macroeconomic theory, it is particularly difficult to adjust wages downwards, so that distortions occur here (wage rigidity). Internal devaluation works best when the prices of trading partner countries rise sharply. In this case, prices and wages in the affected country do not have to be reduced, but only increase less sharply in order to achieve the effect of internal devaluation. In phases of worldwide low inflation, deflationary effects occur with internal devaluation , due to which internal devaluation can only be implemented very slowly and cost-effectively. The process of internal devaluation causes rising unemployment and a decrease in economic growth. Whether and when the increase in competitiveness will offset these costs in the medium term is questionable.

    An internal devaluation is primarily considered if a devaluation of the currency is not easily possible:

    • in a monetary union only the common currency can be devalued (problematic e.g. in the euro crisis )
    • with a fixed exchange rate (e.g. gold standard , Bretton Woods system , currencies pegged to the euro or dollar )
    • if a currency devaluation can cause international conflicts (historically e.g. due to the Young Plan to secure the reparations payments of the German Reich)

    Side effect

    As a side effect of internal devaluation, prices are often distorted, especially because the face value of debt remains the same while property, plant and equipment, goods and services become cheaper. Internal devaluation thus leads to a relative increase in the public and private debt burden both in terms of foreign currency loans and in terms of loans in their own currency.

    practice

    German Empire (1930–1932)

    Due to the Dawes Plan (1924), the Allies did not allow the German Reich to devalue the Reichsmark. (The Young Plan partially removed the Reichsmark, but not with regard to the minimum coverage). Chancellor Brüning tried to improve the Reich's competitiveness through deflationary policies. As a result, prices fell 23% between 1929 and 1933, and wages fell 30%. The value of real estate and goods fell while the value of debt remained constant. Even healthy companies appeared to be over-indebted as a result, were largely unable to service their loans and went bankrupt, and banks became increasingly illiquid. The German Reich was on the verge of civil war.

    Internal devaluations between 1964 and 1990

    According to a study by Jay C. Shambaugh , there was a multi-year phase of internal devaluation in 43 cases in various developed countries between 1964 and 1990. During this period, inflation was relatively high worldwide, so that prices and wages in the affected countries did not have to fall ( deflation ), but only rose less sharply than in other countries.

    Japan (around 2000)

    The deflationary policy from the late 1990s to the early 2000s was one of several attempts to overcome the economic crisis in Japan .

    Germany (after introduction of the euro)

    After the introduction of the euro, Germany experienced a period of economic weakness. According to some economists, competitiveness was reduced because Germany entered the euro currency union at an excessive exchange rate (i.e. at too high a price level) due to political errors. It was only through long-term wage restraint on the part of the collective bargaining parties that the price level was reduced again and thus competitiveness improved. Hans-Werner Sinn sums up the real devaluation as follows: "We have become cheaper and in a certain way also poorer".

    Whether this phase can be qualified as internal devaluation is, however, controversial. This qualification is advocated e.g. B. by Holger Wolf , in contrast, holds z. B. Jay C. Shambaugh considers the differences to the price development of some other countries in the euro zone not to be significant enough.

    Lithuania (2009-2010)

    Lithuania faced the situation that many trading partners had devalued their currencies. Lithuania had, however , pegged its currency to the value of the euro since 2002 , and if the euro peg was abandoned there was a risk of losing economic aid from the European Union. In addition, the central bank advised against currency devaluation, since 89% of private loans were foreign currency loans , the real value of which would have increased if the currency had devalued. There were fears of a debt crisis that would weigh heavily on the economy. In Lithuania there was an internal devaluation of prices and wages by 7% during this period. At the same time, the gross domestic product fell by 25% and the unemployment rate rose to 22% (the recession was thus comparable to the situation in the United States during the Great Depression ). In May 2015, Lithuania had an unemployment rate of 8.2%.

    Ireland

    Ireland was the first euro crisis country to experience internal devaluation from 2008 to 2010. An internal devaluation is recommended by various economists to solve the economic and debt crisis in the PIIGS states. Jay C. Shambaugh counters this by stating that prices in Greece have risen 30% more than in Germany since 1999 (20% more in Spain). In view of the low inflation in Germany, these countries would have to carry out a deflationary internal devaluation for a decade. The exemplary cases of the past would not exactly encourage such a strategy. Barry Eichengreen and Peter Temin point to the teaching of John Maynard Keynes that internal devaluation can work for a single country, but as a collective strategy it becomes suicide. Through internal devaluation (as well as currency devaluation ), competitiveness is only achieved at the expense of trading partners ( Beggar-thy-Neighbor policy ). Since the euro crisis, however, most euro countries and Great Britain have been pursuing a strategy of internal devaluation, which cannot work ( competitive paradox ) or at least less well. For example, the internal devaluation of Germany from 2000 to 2005 contributed to the declining competitiveness of the southern euro countries. While the euro zone with 19 countries had an unemployment rate of 10.2% in April 2016, it had fallen to 7.9% in Ireland.

    Latvia

    In the years before joining the euro on January 1, 2014, Latvia successfully pursued a policy of domestic devaluation. Since the Latvian currency Lat was to remain firmly pegged to the euro, the aim was to increase the country's competitiveness through wage cuts and reduced labor costs. The business newspaper Aktiv described Latvia as a possible model for European crisis countries. After excessive consumption, the country slipped into a deep economic crisis, which the government countered with a rigid austerity policy with “brutal clear cuts” (still without the euro). As a result, Latvia rose to become the “secret euro champion”. An analysis that appeared in the Tages-Anzeiger contradicts this . According to this, the upswing in Latvia (after a decline in economic output of 17.7% in 2009) can be attributed to the easing of credit restrictions and low interest rates. The unemployment rate has decreased due to a large emigration of the population. The austerity measures as the cause could not serve as an explanation. In April 2016, Latvia had an unemployment rate of 9.6%.

    Individual evidence

    1. ↑ Jay C. Shambaugh, The Euro's Three Crises in David H. Romer, Justin Wolfers, Brookings Papers on Economic Activity: Spring 2012 , ISBN 978-0815724322 , Brookings Institution , 2012, p. 179
    2. ^ Center for Economic and Policy Research , Mark Weisbrot , Rebecca Ray , Latvia's Recession: The Cost of Adjustment With An “Internal Devaluation” , 2010, pp. 6.7
    3. ^ Duden Wirtschaft from A to Z: Basic knowledge for school and study, work and everyday life, 5th edition, Mannheim, Bibliographisches Institut, 2013, license edition Bonn: Federal Agency for Civic Education 2013, keyword export multiplier .
    4. ↑ Center for Economic and Policy Research , Mark Weisbrot , Rebecca Ray , Latvia's Internal Devaluation: A Success Story? , 2011, p. 13
    5. ↑ Jay C. Shambaugh, The Euro's Three Crises in David H. Romer, Justin Wolfers, Brookings Papers on Economic Activity: Spring 2012 , ISBN 978-0815724322 , Brookings Institution , 2012, p. 180
    6. ^ International Monetary Fund , World Economic Outlook: Coping with Hight Debt and Sluggish Growth , October 2012, ISBN 978-1-61635-389-6
    7. ↑ Barry Eichengreen , Implications of the Euro's Crisis for International Monetary Reform (PDF; 262 kB), January 2012, p. 1
    8. ↑ Although the determination of an international Reichsbank General Council was abolished in 1930 (Young Plan), the Reichsbank was still subject to international regulations (cf. Klaus Erich Born: Central Banks I: History. In: Handwortbuch der Wirtschaftswwissenschaft, Volume 5, p. 333. ), so in the autumn of 1932 the Bank for International Settlements had to agree to a shortfall (violation of § 29/3 RbG 1924) of the "key interest rate floor" (in the case of a gold currency shortfall) - cf. BIS: 3rd Annual Report (May 8, 1933), p. 29.
    9. ↑ Hans-Werner Sinn, guest article: Ifo boss Sinn advises Greeks to leave the euro , Wirtschaftswoche, July 9, 2011
    10. ↑ The reparation payments to the Allies came to a virtual standstill - to the advantage of Brüning's successors von Papen and Hitler http://www.zeit.de/1955/47/reichskanzler-bruening-70-jahre/seite-2
    11. ↑ Jay C. Shambaugh, The Euro's Three Crises in David H. Romer, Justin Wolfers, Brookings Papers on Economic Activity: Spring 2012 , ISBN 978-0815724322 , Brookings Institution , 2012, p. 181
    12. ↑ Joachim Ahrens and Renate Ohr, 10 Years Treaty of Maastricht , Volkswirtschaftliche Schriften Heft 529, 2003, ISBN 3-428-10879-5 , pages 87, 88
    13. ↑ Jay C. Shambaugh, The Euro's Three Crises in David H. Romer, Justin Wolfers, Brookings Papers on Economic Activity: Spring 2012 , ISBN 978-0815724322 , Brookings Institution , 2012, p. 181
    14. ↑ Philip Plickert: Monetary Union: The advantages and disadvantages of the euro. In: Frankfurter Allgemeine Zeitung. June 22, 2011, accessed January 20, 2013 .
    15. ↑ Holger Wolf, Internal devaluation in a monetary union , International Economics and Economic Policy, April 2011, Volume 8, Issue 1, pages 3–6
    16. ↑ Jay C. Shambaugh, The Euro's Three Crises in David H. Romer, Justin Wolfers, Brookings Papers on Economic Activity: Spring 2012 , ISBN 978-0815724322 , Brookings Institution , 2012, p. 183
    17. ↑ Center for Economic and Policy Research , Mark Weisbrot , Rebecca Ray , Latvia's Internal Devaluation: A Success Story? , 2011, p. 8
    18. ^ Center for Economic and Policy Research , Mark Weisbrot , Rebecca Ray , Latvia's Recession: The Cost of Adjustment With An “Internal Devaluation” , 2010, p. 7
    19. ↑ Jay C. Shambaugh, The Euro's Three Crises in David H. Romer, Justin Wolfers, Brookings Papers on Economic Activity: Spring 2012 , ISBN 978-0815724322 , Brookings Institution , 2012, p. 182
    20. ↑ John Raymond LaBrosse, Rodrigo Olivares-Caminal, Dalvinder Singh, Managing Risk in the Financial System , Edward Elgar Publishing, 2011, ISBN 978-0-85793-381-2 , page 159
    21. ↑ http://ec.europa.eu/eurostat/tgm/table.do?tab=table&language=en&pcode=teilm020&tableSelection=1&plugin=1
    22. ↑ Jay C. Shambaugh, The Euro's Three Crises in David H. Romer, Justin Wolfers, Brookings Papers on Economic Activity: Spring 2012 , ISBN 978-0815724322 , Brookings Institution , 2012, p. 182
    23. ↑ Jay C. Shambaugh, The Euro's Three Crises in David H. Romer, Justin Wolfers, Brookings Papers on Economic Activity: Spring 2012 , ISBN 978-0815724322 , Brookings Institution , 2012, p. 184
    24. ↑ Barry Eichengreen / Peter Temin: Fetters of Gold and Paper, in: Nicholas Crafts, Peter Fearon, The Great Depression of the 1930s: Lessons for Today , Oxford University Press, 2013, ISBN 978-0-19-966318-7 , p . 429-448, here: p. 445
    25. ↑ http://ec.europa.eu/eurostat/tgm/table.do?tab=table&language=en&pcode=teilm020&tableSelection=1&plugin=1
    26. ^ Latvia on the euro zone course
    27. ↑ http://www.aktiv-online.de/nachrichten/detailseite/news/so-vorbildlich-hat-sich-lettland-aus-der-wirtschaftskrise-gekaempft-6680
    28. ↑ Tages-Anzeiger : The Miracle of Latvia , September 25, 2013
    29. ↑ http://ec.europa.eu/eurostat/tgm/table.do?tab=table&language=en&pcode=teilm020&tableSelection=1&plugin=1