International adjustment and finance: Lessons of 1985–91

This is a review article of a conference volume on the effects of dollar depreciation in 1985 on the balances of payments of the U.S., Japan, and Germany. The body of the book consisted of in-depth country studies of changing patterns of foreign trade which asked whether the changes from 1986 to 1990 were consistent with the predictions of economists and the expectations of policymakers. On the basis of the evidence, Krugman concluded that exchange rates do promote adjustment and that the international mechanisms had worked about as well as could be expected from 1986 to 1990. This review article maintains a contrary conclusion; that the overvalued dollar from 1981 to 1985 severely injured the import-competing sector of U.S. manufacturing. As a result, the American external deficit widened for two years after depreciation, and stability was not restored to the external position by 1990 even though the dollar had been at the level of 1980 for about three years. This crippling of import-displacing manufacturing also helps to explain the unique character of the 1990–91 recession.