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November/December 1988, 
Vol. 70, No. 6
Posted 1988-11-01

The Link Between the Value of the Dollar, U.S. Trade and Manufacturing Output: Some Recent Evidence

by John A. Tatom

John A. Tatom examines the basis for this widely assumed inverse relationship and its opposing view, that movements in the dollar’s value are positively related to changes in the U.S. capacity to produce output. As Tatom explains, exchange rates can reflect movements in underlying competitiveness. Thus, factors that reduce the ability of U.S. producers to compete are offset, in part, by a fall in the value of the dollar. Similarly, when those factors raise U.S. competitiveness, the associated gains in domestic output are accompanied by a rising dollar. Examining the evidence, Tatom finds that when the dollar rose, U.S. output and capacity growth, particularly in the industries most associated with the trade deficit, were unusually rapid compared with the past and output growth abroad. These trends evidently have reversed since the dollar began to fall. Tatom concludes that the increased competitiveness produced by economic policy changes in the early 1980s has been reduced by a reversal of some of these policies in the mid-1980s. The confusion over the link between the value of the dollar and U.S. output, according to Tatom, arises from a tendency to see exchange rate movements as the result of mysterious external influences, rather than rational responses to changes in the domestic economic environment.