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December 22, 2004
Exactly What Was I Thinking?
I'm curious about just what macroblog's medium-run scenario is. Is it that a steep decline in the dollar makes foreigners think investments in America are attractive, and so big capital inflows and trade deficits last for a decade or more? Is it that something happens to massively raise America's national savings rate as the capital inflow ebbs? What could that something be?
Actually, the story I was telling was all about reversing the big capital inflows and trade deficits, one that starts with the presumption that foreigner's taste for absorbing ever more dollar-denominated assets has come to an end. The current account side of ending the capital account surpluses -- that is, the accumulation by foreigners of U.S. Treasury securities and the like -- is a shrinking trade deficit, as the weaker dollar stimulates export demand and restrains the demand for imports.
In this scenario, spending by American consumers and businesses will have to be satisfied by domestic production. That will almost certainly result in upward pressure on interest rates, which ought to work in the direction of restraining domestic consumption and increase saving rates (and business investment on plant and equipment, of course), as required.
The central point of agreement -- which we can agree on, because it has to be -- is that reversing the trend in our current account deficits requires that spending in the U.S. fall relative to GDP. I took the Eichengreen scenario to be one in which our trade deficits will be reversed only by direct reductions in domestic spending, which Americans (abetted by U.S. fiscal policy) seem disinclined to swallow any time soon. Hence, the problem gets worse until some really bad stuff happens. I was suggesting that we don't have to wait until the federal deficit turns around or American consumers autonomously decide to shore up their saving accounts. The determination to reduce spending -- by the private sector anyway -- need not come from any sudden enlightenment, but the actions of global investors that will cause the value of the dollar to decline and interest rates to rise, thus putting the price mechanism to work. The only question is whether that process will be orderly, or not.
I can certainly imagine story lines that don't end well. And some may believe -- like the author of one comment to Brad's post -- that my reliance on the logic of conventional, more-or-less "full employment", macro modeling is misplaced. Fair enough. We'll just disagree on that.
One note: I did slightly change the close of the post. The earlier one, which is cited in the DeLong post, finished with this line:
But this [Eichengreen's scenario] is one doomsday case I'm not quite buying.
That didn't sound quite as even-handed as I wanted, so the new finish (which I should have noted) goes like this:
The process I have described could certainly have many elements that make the road from here to there a rocky one. I just don't know. But it is not at all clear to me that Eichengreen's "conclusion is so obvious that the only question is why the markets are not forecasting it already."
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The Soft Landing Scenario
Brad DeLong's Semi-Daily Journal: A Weblog
Macroblog fills in the outlines of its soft-landing scenario: macroblog: Exactly What Was I Thinking?: Actually, the story I was telling was all about reversing the big capital inflows and trade deficits, one that starts with the presumption that forei... [Read More]
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