Monday, February 18, 2013

Joe Scarborough v. Paul Krugman on the Dollar Decline

Paul Krugman and Matt O’Brien are having some fun mocking Joe Scarborough and some senior economist at RAND. The line Paul seized upon was this:
From the beginning of 2002, when U.S. government debt was at its most recent minimum as a share of GDP, to the end of 2012, the dollar lost 25 percent of its value, in price-adjusted terms, against a basket of the currencies of major trading partners.
Paul notes that while the dollar did devalue – in particular during the 2002 to 2008 period, he questions whether or not Scarborough and this RAND economist have the right causation for the devaluation:
the decline in the dollar under Bush probably had more to do with what was going on in our trading partners than with what was going on here. And in any case, again, it was not a problem for America.
Of course those of us who were concerned about the trade deficit back in 2002 might have hoped that we would see a dollar devaluation that might increase net exports. One commenter at Paul’s place, however, argued that the trade deficit continued to increase even as the dollar fell. I checked the NIPA statistics as reported by BEA for how real net exports (2005$) behaved and sure enough, they rose to -$722.7 billion or 5.7% of real GDP by 2005 and were up to -$729.4 billion or 5.6% of GDP by 2006. But then the economy was expanding back in those days. Today, however, real exports are running at -$405.6 billion or 3% of real GDP per 2012. Cynics might say recessions do tend to lower imports and we’d hope that real GDP does eventually take off. A weak dollar, however, is not necessarily a bad thing especially when addressing a weak economy if it makes our goods more competitive in world markets. Of course, any good international macroeconomist would argue that we as well as Europe should be relying more on expenditure-adjusting policies than expenditure-switching policies to stimulate aggregate demand. But this realization seems to be well beyond the comprehension of Scarborough and his economic guru.

1 comment:

Mark A. Sadowski said...

"Of course those of us who were concerned about the trade deficit back in 2002 might have hoped that we would see a dollar devaluation that might increase net exports."

Devaluation improves a country’s trade balance only if the Marshall-Lerner condition on trade elasticities holds, and research shows that they’re not met in the majority of cases, either past or present:

That's not to say that currency devaluation isn't beneficial, it is, but the benefit flows primarily from increased domestic demand. Here is a study of the competitive devaluations of the Great Depression by Barry Eichengreen and Douglas Irwin:

An examination of Figure 4 on page 48 reveals that the only countries that experienced import growth from 1928 to 1935 (the UK, Japan, Sweden and Norway) were members of the sterling block that devalued early (1931). In most of these countries net exports actually declined over the period because imports rose more than exports.

And the order of recovery from the Great Depression follows the order in which they abandoned the gold standard perfectly:

But this wasn't because of increased in net exports.