Another German lesson: the benefits of an exchange rate target

Kaveh Pourvand, 1 May 2013

Yesterday we published An Exchange Rate Target: Why we need one, by entrepreneur and economist John Mills. He argues that the government should set an exchange rate target to lower the value of the pound to help exporters. Some may see this idea as untested and radical, a big jump into the unknown. This is not true. As with so many economic issues, we can look to Germany to see the benefits of a managed exchange rate.

Of course Germany has not had an official exchange target but its membership of the Euro has acted as a de-facto exchange rate policy. Sharing a currency area with weaker southern economies has given Germany the benefit of a significantly weaker currency than it would have had under the Deustchmark. This has been a critical factor in Germany’s very successful export boom of the last few years. As Sebastian Mallaby points out, since 2009 investors have sent their money to stable open economies like Brazil and Switzerland, driving their currencies upwards – incidentally both of these countries imposed capital control measures to arrest these increases.

If Germany had retained the Deutschmark it too would have experienced such capital inflows. Instead, between August 2009 and May 2011, German exports increased by 18 per cent. Mallaby says that this increase would have been only 10 per cent had Germany been outside the Euro. Germany’s recent economic success simply cannot be properly explained without reference to the favourable exchange rate. Since 1999, Germany has gone from having a small deficit to running persistent trade surpluses.

This suggests that if we serious about ‘rebalancing’ and ‘paying our way’ in the world through exports and manufacturing, as now appears to be the consensus, then the impact of the exchange rate has to be a strong concern for policy makers.

(Some readers may point out that the very significant devaluation of the pound has had little impact on the exports, showing that an exchange rate target is futile. I have responded to this criticism here.)