Competitive Effects of Real Exchange Rate Changes
In general, a decline in the real value of a nation’s currency makes its exports and import-competing goods more competitive. Conversely, an appreciating currency hurts the nation’s exporters and those producers competing with imports.
When the real value of the dollar began rising against other currencies during the early 1980s, U.S. exporters found themselves with the unpleasant choice of either keeping dollar prices constant and losing sales volume (because foreign currency prices rose in line with the appreciating dollar) or setting prices in the foreign currency to maintain market share, with a corresponding erosion in dollar revenues and profit margins. At the same time, the dollar cost of American labor remained the same or rose in line with U.S. inflation. The combination of lower dollar revenues and unchanged or higher dollar costs resulted in severe hardship for those U.S. companies selling abroad. Similarly, U.S. manufacturers competing domestically with imports whose dollar prices were declining saw both their profit margins and sales volumes reduced. In a great reversal of fortune, Japanese firms then had to cope with a yen that appreciated by more than 150% in real terms between 1985 and 1995.