D. Trends in Effective Exchange Rates

The combination of growing capacity in the rest of the world relative to that of the U.S. and roughly comparable cost develop¬ ments led to a significant drop in the U.S. share of world exports in manufacturing from 1950 to 1970. This in turn built pressure for a devaluation of the U.S. dollar. Under the Bretton Woods system, a dollar devaluation was effectively ruled out, so the U.S. trade balance deteriorated after reaching a peak surplus in the early 1960s. Pressure grew and the system broke down in 1970-71; the U.S. exchange rate moved to re-establish equilibrium. The real effective exchange rate was frozen during the period 1950-70, but has worked reasonably well since as an adjustment mechanism.
Table 7 shows index numbers for the U.S. nominal effective ex¬ change rate in column (1), relative wholesale price indexes (WPIs) in column (2), and real effective exchange rates in column (3) for the period 1961-78. The period breaks clearly into two subperiods: 1961-70, in which the three series are fairly constant, and 1970-79, in which the effective rates depreciate substantially.
During the 1960s, the U.S. WPI fell slightly relative to the weight¬ ed average of those of the other industrial countries, from 102.6 in 1961 to 98.4 in 1970. This reflects the stable performance of relative unit labor cost shown above in Table 5. The effective nom¬ inal exchange rate also fell slightly during this period— an up valua¬ tion or appreciation of the U.S. dollar as other exchange rates moved. Consequently, there was almost no movement in the real effective rate as the U.S. lost trade shares.
Beginning in 1971, nominal bilateral rates began to move sub¬ stantially, and the U.S. real effective rate began to adjust. From 1 970 to 1 979 the foreign exchange rate of the U.S. dollar fell and the index increased from 83.2 to 1 08.4, as shown in column (1 ) of Table 7.
128
Critical Issues & Decisions
TABLE 7
U.S. EFFECTIVE EXCHANGE RATES, 1961-79 1975= 100
YEAR
(D
Effective
Exchange
Rate1
(2)
U.S. WP'I
Relative to Competitors
(3)
Real Effective Exchange Rate (3) = (1) -- (2) x 100
1961
85.0
102.6
82.9
1962
84.3
101.7
82.9
1963
84.2
99.7
84.4
1964
84.2
98.2
85.7
1965
84.2
98.0
85.9
1966
84.2
98.4
85.6
1967
84.0
98.7
85.1
1968
82.6
99.0
83.5
1969
82.4
99.3
83.0
1970
83.2
98.4
84.5
1971
85.5
98.3
86.9
1972
93.0
98.4
94.5
1973
101.4
98.3
103.2
1974
98.9
99.7
99.2
1975
100.0
100.0
100.0
1976
95.2
103.1
92.3
1977
96.2
100.9
95.3
1978
106.2
93.9
113.1
1979
108.4
93.0
116.6
1
This is the inverse of an index of the weighted average of foreign exchange prices of the U.S. dollar.
Source: International Monetary Fund
Critical issues & Decisions
From 1970 to 1974, U.S. price performance roughly matched the average of its competitors', as shown in column (2) of Table 7. From 1975 to 1977, during the recovery from the 1974-75 recession, U.S. prices rose relative to the competitors' index, but this movement was reversed in 1978-79. The movements in relative prices since 1974 have tended to make swings in the real effective rate bigger than those in the nominal rate, as a comparison of columns (1) and (3) will show.
Broadly speaking, U.S. price performance has been roughly com¬ parable to that of its industrial competitors since 1960. During the decade 1960-70, the nominal effective U.S. rate was essentially constant (with a small upward creep due to an occasional devaluation in one of the other countries), and so was the real effective rate. With capacity growing abroad, the U.S. lost trade shares. In the 1970s movement in the nominal effective U.S. rate has brought about a real effective devaluation of nearly 40 percent, and the shrinkage of export shares has been halted. It appears that the real effective rate has worked as an instrument for adjustment and that its movements have come through movements in the nominal rate with roughly parallel price performance.