Internal versus external devaluation – Real-World Economics Review blog


From Merijn Knibbe at Real-World Economics Review blogInternal versus external devaluation; two examples:

Wages are sticky by nature – and they already were that way back in the eighteenth and nineteenth century. It’s not a modern phenomenon. They don’t go down easily. Flexible exchange rates are a much better, faster and more effective way to decrease labor costs and enhance the internal and external competitive position of an economy than Danish ‘flexicurity’, Baltic ‘internal devaluation’ or other ways to increase unemployment and therewith decrease labor costs. And they also enable a country to weather grave economic disturbances…

Starting in October 2008, the Polish Zloty and the Swedish Krona started to depreciate, which led to much lower labor costs – and a much smaller economic downturn than in countries which rigidly adhered to a pegged exchange rate.

In both cases depreciation not only led to a stronger competitive position on the domestic as well as the international market but it also enabled a looser monetary policy, which also boosted the economy…

It seems that external devaluation did enable Sweden and Poland to manage the shock of 2008, while internal devaluation, flexible labor markets, easy firing and high unemployment did not save Denmark and the Baltics. As a result, employment and unemployment developed much better in Poland and Sweden, while wages (in euro) are already more or less back to their initial level…

Read more.

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