December 21, 2004
Macroblog Thinks Barry Eichengreen Is Too Pessimistic
macroblog: Does A Current Account Correction Spell Doom?: There is a world of difference between falling investment and consumption growth that arises because spenders are pessimistic , or facing higher taxes, or whatever, and falling investment and consumption that is prompted by higher interest rates resulting from an excess demand for goods and services. It seems to me that the latter is the relevant situation in the Eichengreen/DeLong scenario, and I don't think even conventional Keynesian-types are apt to predict recessions when the fundamental dynamics in the economy point to overheated demand.
Somehow the Fed gets wrapped up into all of this. I agree it could be the case that "[T]he Federal Reserve will have to raise interest rates faster than currently expected." But as I explained here, a higher feds fund rate target in an environment of rising of market rates is not necessarily the same thing as tighter monetary policy. And while it may true that the falling dollar and resulting current account adjustments could yield some upward pressure on the price level, those pressures should be temporary. The FOMC has worked long and hard to keep such transitory ups and downs in the rate of inflation from becoming embedded in private expectations. We can at least hope that Fed credibility will see us through whatever adjustments are to come, without the need for extraordinary measures to contain the inflation trend.
None of this to say that the reversal of our current account deficits will occur seamlessly, or without some sort of disruption to the U.S. economy. I just don't know. But this is one doomsday case I'm not quite buying.
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?
Posted by DeLong at December 21, 2004 08:48 AM