Brad DeLong's Semi-Daily Journal (2004)

A Dirty Job. But Somebody Needs to Do It

*Sigh.* It's the first day of the new quarter, so it's time for me to take on my share of intellectual cockroach control. It's a dirty, unpleasant job. But it needs to be done, and I should do my share. So:

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Don Luskin criticizes Larry Summers and Paul Krugman for having in the early 1980s forecast a decline in the value of the dollar:

The chart below shows the real exchange rate of the US dollar for a decade before the 1982 memo, and then through the end of the Reagan presidency. It did drift slightly lower for the first couple of years after the memo. But then it took off to new highs -- nothing resembling anything like a "return to approximately their historical levels."

But there is something important that Luskin does not know that you need to know. In this chart, "highs" does not mean what Luskin thinks it means. Luskin has constructed a chart not of the value of the dollar but of the price of foreign currency in dollars: when the value of the dollar falls, the price of foreign currency in dollars rises. Luskin's "taking off to new highs" after early 1985 is Krugman's prediction of lower dollar values coming true. Add incompetence in reading data definitions to the list of Luskin's sins. (Also add ignorance: I didn't know there was anyone connected to financial markets who did not recall that the value of the dollar fell substantially between the Plaza Meeting of 1985 and the Louvre Meeting of 1987.)

Moreover, what Luskin has plotted here is not the real exchange rate: the U.S. real exchange rate did not change by a factor of three between 1973 and 1988. I suspect that what Luskin has done has been to divide a nominal exchange rate series by the home country's price level, rather than by the ratio of the home to the foreign price level, and thus created a series that is essentially meaningless. (But however he has created this series, add incompetence at data construction to the list of Luskin's sins.)

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UPDATE: Chef Ragout reports that Donald Luskin has figured out that the real exchange rate looks like this:

and not like this:

What does Luskin call the difference between the two series? A nit-picky "analytic detail."

:-)

Posted by DeLong at July 1, 2004 06:13 PM | TrackBack | | Other weblogs commenting on this post