The Times on the Dollar
By Greg Mankiw
The editorial writers at the New York Times have either forgotten their basic international macroeconomics or have a new theory of it that I do not understand. Here is what they say about the trade deficit and the exchange value of the dollar:
Over the last several years, America's imbalances in trade and other global transactions have worsened dramatically, requiring the United States to borrow billions of dollars a day from abroad just to balance its books.
The only lasting way to fix the imbalances — and reduce that borrowing — is to increase America's savings. But the administration has steadfastly rejected that responsible approach since it would require rolling back excessive tax cuts and engaging in government-led health care reform to rein in looming crushing costs — both, anathema to President Bush. It would also require revamping the nation's tax incentives so that they create new savings by typical families, instead of new shelters for the existing wealth of affluent families — another nonstarter for this White House.
Stymied by what it won't do, the administration has gone for a quicker fix — letting the dollar slide. A weaker dollar helps to ease the nation's imbalances by making American exports more affordable, thus narrowing the trade deficit....
In the absence of leadership from the White House, the presidential candidates could elevate the issue, outlining their own plans to boost savings. But until the administration — either this one or the next — is willing to acknowledge the source of the economy's imbalances, and starts addressing them seriously, the dollar is likely to remain weak.
I am all for taking steps to increase national saving, such as reforming the tax code to tax consumption rather than income and reducing the budget deficit through a combination of entitlement reform and additional revenues using Pigovian taxes. (Recall this op-ed of mine.) But the Times fails to acknowledge that increased U.S. saving will, according to standard macroeconomic theory, weaken the exchange value of the dollar.
This is described fully in Chapter 32 of my favorite economics textbook. The intuition is that higher saving will reduce the interest rate that equilibrates the market for loanable funds. (Equivalently, one could say that it lowers the interest rate consistent with output and employment at their natural rates.) Lower U.S. interest rates will discourage the inflow of capital from abroad. The reduced flow of capital into the United States will reduce the demand for dollars, thereby decreasing value of the dollar in foreign exchange markets.
If more saving means a weaker dollar, it seems odd to argue, as the Times seems to be, that a weak dollar reflects our failure to save enough. gregmankiw.blogspot.com |
