councilor.org
| Source | Jim Devine |
| Date | 00/01/12/10:56 |
| According to the textbooks, an open economy with easy flow of financial
money capital and flexible exchange rates makes monetary policy _more_ powerful. If the Fed lowers rates, that causes a lower dollar, cet. par. (due to capital mobility), which eventually increases the volume of US net exports. (This doesn't happen immediately, since there's a J-curve effect, in which the immediate effect of a lower dollar is to reduce net exports.) In addition, if we're talking about a financial "collapse" (which then spreads to the rest of the economy), the Fed is quite practiced at arriving at Wall Street with trucks of cash to prevent contagion, as with the crash of 1987. (The infusion of cash into financial markets would threaten anti-inflation goals, but I'm sure that Saint Alan values the Market more than he does price stability.) Of course, there's little Saint Alan can do about contagion to financial markets and institutions out of the U.S. unless He can quickly get other Central Bankers to also pump in the cash. One problem with the Fed-induced fall in the dollar is that it might cause a sudden fall, which would encourage a speculative collapse of the dollar, encouraging the dollar to lose its status as the world's main reserve currency (encouraging international financial chaos). That would likely encourage the Fed to engage in tight monetary policy, because the US does not want the dollar to lose its exalted status, especially if it might be replaced by the Euro. This fall from grace would be made worse if the nabobs of the financial markets consider His policy to be inflationary (and they're typically big inflation hawks unless their skins are on the line). It seems to me that the best the Fed can do is to induce a gradual fall in the dollar (probably with some sort of prior announcement of the general plan for depreciation). This fall might occur too slowly to prevent, moderate, or reverse a US recession, especially given the J-curve effect. BTW, if the Fed ups rates this week, they're moving exactly in the opposite direction from a gradual fall of the dollar. But Saint Alan has reversed himself in the past, as when he cut rates in response to the East Asian financial crisis. So it's possible that the Fed could switch to the "gradual fall" policy. Even if the dollar's fall is gradual, it would encourage inflation in the US, since so many important goods are imported. It would also undermine the trade surpluses of other countries, which would undermine their economies further. The US -- or rather the US private sector, especially consumers -- is acting as the consumer of the last resort to the rest of the world. A fall in the dollar would end this stimulus, as would a recession in the US as consumers adjust their consumption to be in line with their incomes. It's quite possible that the resulting fall in the rest of the world's economies could lead to a fall in US net exports, encouraging a further fall in the US economy (note that I'm assuming a recession here), which then bounces back to depress the rest of the world. (This is an international multiplier effect.) This vicious circle could cause a deepening world depression. Note that if all -- or almost all -- countries are suffering from recessions, exchange rates would stay roughly constant, so that none would benefit from the usual domestic demand stimulus resulting from a lower currency. The best way for Him to prevent a world depression (while preserving the dollar's status) would be to engineer a coordinated cut in interest rates among the major Central Banks. But this would likely preserve the large and growing US current-account deficit. That is representing a growing problem. More and more I get the feeling that the US growth process is one that is based on optimism (a bubble extending beyond financial and other asset markets), with increasing amounts of optimism being needed to sustain the process. Falling interest rates could substitute for optimism, but that would encourage the bubble more, encourage increased consumer indebtedness more, and threaten the reserve status of the dollar. So there are clear limits on His ability to pull off a miracle. It's a little like the cartoon character Wile E. Coyote who runs off the cliff and then keeps on running, not knowing that the abyss is below. (Alain Lipietz used this metaphor years ago, to describe a "slow 1929." More and more I think it's appropriate.) I have to go now, so the above feels pretty incomplete. I recommend Tom Palley's article in the most recent issue of CHALLENGE (despite the grevious editing errors), Robert Blecker's article "The Ticking Debt Bomb" at http://www.epinet.org/ , and Wynne Godley's article "Seven Unsustainable Processes." at http://www.levy.org/ . |
Copyright (c) 1998, Joongpil Cho