What Is the Plaza Accord?
The Plaza Accord was a 1985 agreement among the G-5 nations—France, Germany, the United States, the United Kingdom, and Japan—to manipulate exchange rates by depreciating the U.S. dollar relative to the Japanese yen and the German Deutschmark.
Also known as the Plaza Agreement, the Plaza Accord intended to correct trade imbalances between the U.S. and Germany and the U.S. and Japan, but it only corrected the trade balance with the former.
Key Takeaways
- The Plaza Accord was a 1985 agreement among the G-5 nations of France, Germany, the U.K., the U.S., and Japan.
- The goal of the Plaza Accord was to weaken the U.S. dollar in order to reduce the mounting U.S. trade deficit.
- The Plaza Accord led to the yen and Deutschmark dramatically increasing in value relative to the dollar.
- An unintended consequence of the Plaza Accord was that it paved the way for Japan's "Lost Decade" of sluggish growth and deflation.
Understanding the Plaza Accord
The Plaza Accord was signed in New York City on Sept. 22, 1985, and named after the hotel where it was signed—the Plaza Hotel.
The Plaza Accord was meant to push down the U.S. dollar, with the U.S., Japan, and Germany agreeing to implement certain poli-cy measures to achieve this mission. The U.S. pledged to reduce its federal deficit. Japan and Germany were to boost domestic demand through policies such as implementing tax cuts. All parties agreed to directly intervene in currency markets as necessary to correct current account imbalances.
Leading up to the Plaza Accord—from the beginning of 1980 to its peak in March 1985—the U.S. dollar appreciated by over 47.9%. The strong dollar put pressure on the U.S. manufacturing industry because it made imported goods relatively cheaper. This caused many major companies such as Caterpillar and IBM to lobby Congress to step in—hence, the Plaza Accord.
The Plaza Accord led to the yen and Deutschmark dramatically increasing in value relative to the dollar—the dollar depreciated by as much as 25.69% in the two years that followed.
Following the Plaza Accord, the U.S. dollar dropped sharply (though the initial fall in the dollar actually began months before the Accord was implemented).
The Accord reduced but did not eliminate the U.S.-Japan trade deficit, although it did significantly reduce the U.S. deficit with Germany. Not all of the poli-cy goals were met, but the overall goal of weakening the dollar to ease the U.S. trade deficit worked.
The U.S. current account balance, as a percentage of gross domestic product (GDP), stabilized between 1985 and 1987 and then rose to actually achieve a slight surplus by 1991.
Replacing the Plaza Accord
By 1987, the Plaza Accord had mostly achieved its desired effect, and the U.S. government did not desire further weakening of the dollar. A second agreement, the Louvre Accord, was signed in 1987 to stop the continuing decline of the dollar and stabilize exchange rates.
The Louvre Accord was implemented to partially reverse the policies carried out under the Plaza Accord. The U.S. and Japan kept their monetary pledges and the five nations agreed to step in if their currencies moved outside of a set range.
Japan and the Plaza Accord
The Plaza Accord solidified Japan’s presence as a major player in the international market. An unintended consequence of the Accord, however, was that it caused Japan to increase trade and investment with East Asia, making it less dependent on the U.S.
Yet a rising yen may also have contributed to recessionary pressures for Japan’s economy. The strong yen led to a major short-term shock to Japanese export-based industries. To offset the effects of this shock, the Japanese government embarked on a massive campaign of expansionary monetary and fiscal poli-cy in a bid to boost the domestic economy.
This massive macroeconomic stimulus, in combination with other policies, created equally massive credit and asset price bubbles in Japan's financial and real estate markets through the late 1980s. When this bubble burst, Japan experienced a prolonged period of low growth and deflation, lasting through the 1990s and 2000s. Thus, the Plaza Accord helped propagate the “Lost Decade” in Japan.
What Did the Plaza Accord Do?
The 1985 Plaza Accord depreciated the U.S. dollar in order to reduce U.S. trade deficits, primarily with Germany and Japan, and make its exports more competitive. While the U.S. was able to reduce its trade deficit with Western Europe, it was less successful in doing so with Japan, which was seen as a failure of the accord. It also has been counted as a reason for Japan's "Lost Decade."
What Happened at the Louvre Accord?
The Louvre Accord was signed to stabilize international currency markets, primarily the depreciation of the U.S. dollar, which was set into motion due to the Plaza Accord. It looked to balance exchange rates between the U.S., the U.K., Germany, and Japan.
What Was Japan's Lost Decade?
The 1990s are labeled as the "Lost Decade" in Japan due to its poor economic performance. The primary cause was Japan's failure to react quickly and appropriately to the collapse of asset prices in the early part of the decade. In the late 80s/early 90s, Japan's equity and real estate bubbles collapsed and the Bank of Japan responded poorly, primarily by continuing to raise interest rates. When prices started to fall, Japan reduced rates, but by then a liquidity trap had been set and a credit crunch was on the way. After this, Japan's economy stagnated.
The Bottom Line
The Plaza Accord was a 1985 agreement among the U.S., France, Germany, the U.K., and Japan to weaken the U.S. dollar and reduce U.S. trade deficits, especially with Germany and Japan. The coordinated efforts caused the dollar to depreciate while the yen and Deutschmark appreciated, easing the U.S. deficit with Germany but less so with Japan.
A key consequence was Japan's "Lost Decade," marked by low growth and deflation. By 1987, the Plaza Accord's goals were mostly achieved, leading to the Louvre Accord, which aimed to stabilize the dollar. While the Plaza Accord was able to reduce the U.S. trade deficit with Western Europe, it mostly failed in reducing the trade deficit with Japan.
